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

Tuesday, October 26, 2010

Transcript: 409 Shrinking our way to growth

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Shrinking our Way to Growth -- the Austerity Prescription

The Austerity camp has taken control of the public agenda. Today we have Paul Krugman and Martin Wolf to help us push back. Next time, we'll give you some Robert Pollin. Also today some observations from Rick Davis on the psychology of the household -- the FUD index -- Fear, uncertainty and doubt.

First we have a market minute. Demand Side is no expert in how to make money in financial markets. Our advice for the past decade has been to sell, sell, sell. We have not yet mastered the details of how economic weakness translates into financial asset strength. But here is Mike Larson, an analyst for Weiss Research and editor of the Safe Money Report, courtesy of Marketwatch.


Indeed, someday the casino economy will drain away all possibilities for the real economy, but if there is money to be made ....


In this election season political strategy has trumped public service. It is an open question whether the winner of the election will find his prize worth winning, since it has crystallized or calcified policy around austerity, which can only lead to further decline. As we've said before, we're still in 1930. But we'll get to that in a moment. Here, quoting from Rick Davis at Consumer Metrics Insitute via Global Economic Intersection, we have some salient observations on the economic effect of the elections. Davis maintains the FUD -- frustration, uncertainty and doubt -- index. From his latest post:
... the incessant and mutual mud-slinging (however merited) is actually designed to cast doubt in the minds of consumers about the competence of their current/potential leaders and the long term prospects for the economy under their current/potential leadership.


Unfortunately (and unlike earlier elections in less economically stressful times), until unemployment moderates significantly and household wealth and income start to grow, much of the mud-slinging will ring true. It’s much harder to dismiss the accusations this time around as normal political hyperbole. Visions of a debt-driven economic dystopia, once unleashed via well-funded campaign ads, could to some extent be self fulfilling.

The conventional wisdom about this particular electoral cycle is that the fear factor is coming from uncertainty about 2011 tax rates, given both the expiring tax cuts and the need to address deficits. If taxes are about to go up, rational consumers should be expected to increase personal savings in anticipation of looming tighter budgets. However, the dramatic short term effects that we monitored in 2008 — and are seeing again this year — suggest that something less rational and more emotional is at the root of these changes in consumer behavior. People act on gut reactions, even if it is sometimes subconscious.

If consumers feel powerless in the face of a “Wall Street and Beltway” oligarchy, they may take cheer from having their collective say on November 2. Such cheer was palpable in 2008, when the incoming administration was given a clear mandate (and the legislative wherewithal) for change. This time around, however, the cheer could be muted by the realization that gridlock merely locks in the status quo.

In 2008 we saw a rapid improvement in consumer demand after the electoral smoke cleared. In fact, we saw demand for durable goods (as reflected in our Weighted Composite Index) return to net year-over-year growth by November 30, and our trailing ‘quarter’ Daily Growth Index return to net growth by January 3. This growth was led by a strong housing sector, which by the end of the year was growing at a 50% year-over-year clip. Considering the backdrop for that sector heading into this electoral cycle, this time the lead will need to come from somewhere else.

Rick Davis at Econ Intersect. We put up the entire post on Saturday.
Now How does shrinking your economy lead to growth?

The election season claim that business creates jobs is not correct. If business created jobs in the absence of government regulation and health care legislation, then the eight years of the Bush administration would have seen robust hiring. Instead employment as a proportion of the employable population peaked in 2000, and it has been downhill since. The Bush II presidency saw the lowest production of jobs in any presidency in the post-war era. In spite of the radical reduction of taxes and regulation, business investment was tepid. Virtually all investment came from residential real estate and ancillary industries. All financed by an explosion of household borrowing.

Businesses and their CEO's who now trumpet their ability to create jobs have been in the business of destroying jobs over the past three years, to protect their bottom lines. Thus, it is not government, whose deficit supports whatever stability there is, but the mountains of cash on the sidelines, on banks and corporate balance sheets, that is the placeholder for employment. Uncertainty about regulation and health care is an excuse, a substitute for an explanation.

Before we continue, we should ask who the most prominent proponents of the austerity prescription are? It turns out, particularly in the case of the IMF, they are the same voices who have been guilty of economic malpractice for decades. They are the supporters of securitization, rational expectations, market efficiency and the mathematics-based risk models that failed so spectacularly over the past three years. Absent from this group are any of those who correctly predicted the disaster.

Here is Paul Krugman speaking with George Stephanopolous


Here and we'll have audio from him next time -- we have Robert Pollin. Pollin is co-director of the Political Economy Research Institute at UMass Amherst. Quoting from the abstract of his recent paper entitled, "Austerity is Not a Solution: Why the Deficit Hawks are Wrong:
"Wall Street hyper-speculation brought the global economy to its knees in 2008-09. To prevent a 1930s-level Depression at that time, economic policymakers throughout the world enacted extraordinary measures. These included large-scale fiscal stimulus programs, financed by major expansions in central government fiscal deficits. In the U.S., the fiscal deficit reached 9.9 percent of GDP in 2009, and is projected at 10.3 percent of GDP in 2010. But roughly 18 months after these measures were introduced, a new wave of opposition to large-scale fiscal deficits has emerged.

The arguments developed by various leading deficit hawks are not advancing one main argument or even a unified set of positions, but rather four distinct claims: 1) Large fiscal deficits will cause high interest rates, large government debts, and inflation; 2) Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence; 3) The multiplier for fiscal stimulus policies is always close to zero and has been so with the current measures; and 4) Regardless of short-term considerations, we are courting disaster in the long run with structural deficits that the recession only worsened.

None of these deficit hawk positions stand up to scrutiny. Pollin argues that by critiquing the four deficit-hawk positions, we can also bring greater clarity toward developing a workable recovery program. This will include fiscal deficits that can stabilize state and local government budgets; maintain sufficient funds for unemployment insurance; and continue support for long-term investments in traditional infrastructure and clean energy. But such fiscal policies also need to combine with credit-market measures that are capable of ‘pulling on a string’—i.e. creating strong enough incentives for both lenders and borrowers to unlock credit markets.
In Europe Austerity has been championed by the new British prime minister, David Cameron. As leader of the Conservative Party, Cameron is a prime illustration of why conservative is a very poor synonym for prudent. The austerity package presented by Cameron was lauded by the IMF, an organization notorious for poor economic judgement, yet still at the heart of official policy making. Here is an edited version of Martin Wolf's comments.


Martin Wolf

Both Wolf and Krugman are counting on consumer demand to return by way of tax cuts, to overstate their positions. It is Demand Side's point of view that reconstruction of aggregate demand must be experienced in the household sector in the form of jobs. Tax cuts will be saved or directed to debt payments. This will have a very low multiplier. Jobs create demand for the entire spectrum of consumer purchases. And to expect industries devoted to consumer production to invest is expecting investment in China to stimulate the U.S. or Europe.

Demand Side requests immediate and large-scale public investment in education, infrastructure, energy and climate change related projects. Direct investment -- perhaps financed off budget by dedicated bonds -- but nevertheless direct employment of people. It is this single-minded resussitation of aggregate demand through public goods that will return us to economic health. If in the course of creating that demand we preserve the planet for human civilization and prepare for the prosperity, so much the better. To rely on the consumer economy's return is to rely on the dynamics that wrecked the economy, including debt, to return as its salvation.

Sunday, October 24, 2010

Are there economic speeches that need to be given? Robert Kuttner offers two

Two Speeches Obama Should Give -- and Probably Won't

Robert Kuttner
October 24, 2010

Is the election basically sewn up, with the House gone and the Senate hanging in the balance? If things continue as they have been going, almost surely.

Voters are still seeking some signs that the Democrats are on their side. Here are two speeches Obama should give, and probably won't. One concerns Social Security, the other the incipient Banking Crisis II.

My fellow Americans, Social Security is one of the bedrock programs that Democrats have always fought for. In a deep recession, protecting Social Security is more important than ever. Two-thirds of seniors depend on Social Security for more than half their income.

Thanks to the banking collapse produced under my predecessor's administration, older Americans have lost a lot the equity in their homes, much of their savings, and retirement plans such as 401k's. But Social Security is the one part of retirement income that your government guarantees because you have prepaid it with your taxes all of your working life.

Now, with Americans reeling from the costs of recession, many Republicans are calling for a human sacrifice. They want to raise the retirement age, or privatize Social Security, or otherwise cut benefits.

Some leading Republican congressmen who will assume leadership positions if the Republicans take control of Congress are on record favoring Social Security cuts. Some Republican candidates even say Social Security is unconstitutional.

Even in my own party, a few people think Social Security needs to be cut in order to demonstrate that Washington is serious about reducing the federal deficit. Yes, the deficit needs to be brought under control - but Social Security is in surplus for the next 27 years!

We can reduce the deficit without balancing the budget on the backs of seniors. I am happy to have this argument with Republicans and with the few Democrats who would tamper with Social Security out of sincere but misguided concern for fiscal balance.

So as long as I am president, there will be no cuts, no privatization, and no raising of the retirement age. Social Security will be there not only for today's retirees, but for their children and grandchildren. If we want to put Social Security in the black forever, the best way to do it is to put Americans back to work and raise their wages, since Social Security is financed by payroll taxes.

Whatever your partisan preference, I hope you will vote on November 2. And before you vote, you might want to ask your favorite candidate whether he or she has taken the pledge that I have taken--never to support cuts in Social Security.

This should be as natural to Democrats as breathing. Conservatives will say it is "demagoguery" to fail to join the chorus calling for deep cuts in entitlements. But the real demagoguery is trying to blame Social Security for a financial meltdown in which Social Security played no role, or to make Social Security take a hit for the sins of others.

Here is speech Number Two:

Friends, I have had it with the big banks. When the whole banking system was about to collapse in 2008 and take the economy down with it, I reluctantly supported relief to the banks. The banks have now paid back nearly all the money under the so-called TARP program. They are profitable again.

I coupled that relief with a call for stringent reform of banking practices, so that no bank would ever again be "too big to fail." Congress, in passing the Dodd-Frank Act last July, provided most of what I requested, including the power to shut down and reorganize large financial institutions that pose systemic risks.

But now we learn that the banks that created the monster of sub-prime loans were not just taking advantage of borrowers with deceptive terms, and of innocent investors who bought bonds backed by sub-prime loans. The banks also put the whole system on automatic pilot, and hired people to sign false affidavits that the mortgages were properly documented.

A great many of the mortgages, and the bonds backed by the mortgages, turn out to have false documentation. In plain English, that means houses can't be sold, because it's not clear who owns them. And if a property has been foreclosed, the bank can't take it back.

This is a needless catastrophe for homeowners, for the banking system, and for pension funds or mutual funds that bought these bonds. The bonds, backed by dubious loans, were already worth less than their face value because of the low quality of the underlying mortgages. Now, many of them may be worth nothing.

All of this was the result of greed, pure and simple. Banks were making so much money, so fast, that they couldn't even slow down long enough to properly document the mortgage loans.

Their greed has undercut one of the most fundamental pillars of our economic system, ownership of private property -- the ability to know for certain when you own something, and to be confident that when you buy something as important as your house, that the person who is selling it actually owns it. The bankers created a doomsday machine.

The people who created this legal mess on top of an economic mess have been lobbying my administration to come up with some kind of quick fix, so that all of these improper mortgages will somehow be okay. And I have told them that there will be no quick fixes at the expense of the tens of millions of ordinary homeowners who have been the victims of these scams. The fact that they were perpetrated by some of the biggest banks in our country makes them all the more shameful.

So today, I am instructing Treasury Secretary Timothy Geithner, as authorized by the Dodd-Frank Act, to call an emergency meeting of the newly created Financial Stability Oversight Council that he chairs. I have asked him to declare that a systemic emergency exists, and to come back with a three-part program.

Part one will investigate just how many of the nation's mortgages and bonds backed by the mortgages are not legally valid. We will devise a way of turning these into proper loans, but only as part of a broader program of relief to homeowners.

Part two will provide a more effective system of refinancing mortgages than the present HAMP program, so that people who took out mortgage loans in good faith and then found themselves under water, can keep their homes. This is not a handout, this is justice. Ordinary people will get no more than bankers got -- and no less.

Part three will determine which banks are insolvent as a result of this latest banking mess. Those banks will be restructured, under the new authority of the Dodd-Frank Act, and will be returned to sound operation so that they can serve the credit needs of Americans. No taxpayer money will be required.

My friends, banks are here to serve us, not to take advantage of us. I will not let the short-sightedness of a few people on Wall Street take down the economy for the second time in three years.

Wait, you say this doesn't sound much like Barack Obama? No, it doesn't. His loss -- and probably ours.

Saturday, October 23, 2010

Fear Uncertainty and Doubt

Political “FUD” and the Consumer Psyche

Posted on 19 October 2010 by Rick Davis

Note:  Global Economic Intersection welcomes Rick Davis as a regular contributor.  Rick is founder and CEO of the Consumer Metrics Institute follows the state of the economy as reflected by consumer discretionary durable goods spending.

Fear, uncertainty and doubt (“FUD”) in any form increases cautious behavior, and in the case of consumers that might just reinforce new-found habits of frugality.  As we predicted in August, the biennial U.S. political insanity is having its usual effect on the consumer psyche.

► To the best of our knowledge, the daily resolution of our data provides the only major source of insight into this phenomenon. We saw it happen twice in 2008, during the Democratic National Convention and again in the run-up to (and immediate aftermath of) the election itself. However, on October 15, 2008 our Weighted Composite Index was basically neutral and our Daily Growth Index had already improved from its recent bottom by nearly 1.5%. In contrast, at the same point in this electoral cycle our Weighted Composite Index is contracting at a more than -7% year-over-year rate, and our Daily Growth Index is in record territory and has yet to form a lasting bottom.

► The political theater alone could be distracting. But the incessant and mutual mud-slinging (however merited) is actually designed to cast doubt in the minds of consumers about the competence of their current/potential leaders and the long term prospects for the economy under their current/potential leadership. Here at the Consumer Metrics Institute we are merely left to assess the collateral damage being done to the economy on a daily basis.

► Unfortunately (and unlike earlier elections in less economically stressful times), until unemployment moderates significantly and household wealth and income start to grow, much of the mud-slinging will ring true. It’s much harder to dismiss the accusations this time around as normal political hyperbole. Visions of a debt-driven economic dystopia, once unleashed via well-funded campaign ads, could to some extent be self fulfilling.

► The conventional wisdom about this particular electoral cycle is that the fear factor is coming from uncertainty about 2011 tax rates, given both the expiring tax cuts and the need to address deficits. If taxes are about to go up, rational consumers should be expected to increase personal savings in anticipation of looming tighter budgets. However, the dramatic short term effects that we monitored in 2008 — and are seeing again this year — suggest that something less rational and more emotional is at the root of these changes in consumer behavior. People act on gut reactions, even if it is sometimes subconscious.

► If consumers feel powerless in the face of a “Wall Street and Beltway” oligarchy, they may take cheer from having their collective say on November 2. Such cheer was palpable in 2008, when the incoming administration was given a clear mandate (and the legislative wherewithal) for change. This time around, however, the cheer could be muted by the realization that gridlock merely locks in the status quo.

► In 2008 we saw a rapid improvement in consumer demand after the electoral smoke cleared. In fact, we saw demand for durable goods (as reflected in our Weighted Composite Index) return to net year-over-year growth by November 30, and our trailing ‘quarter’ Daily Growth Index return to net growth by January 3. This growth was led by a strong housing sector, which by the end of the year was growing at a 50% year-over-year clip. Considering the backdrop for that sector heading into this electoral cycle, this time the lead will need to come from somewhere else:

Although we hate to beat a dead horse, until our numbers begin to improve, our message must remain unchanged. Political FUD has again reared its ugly head, and (as expected) it has driven our Daily Growth Index back down again towards record territory:

The broader and more extended impact of this election cycle’s FUD is evident from a look at our “Contraction Watch” chart. In that chart, the day-by-day courses of the 2008 and 2010 contractions are plotted in a superimposed manner, with the plots aligned on the left margin at the first day during each event that our Daily Growth Index went negative. The plots then progress day-by-day to the right, tracing out the changes in the daily rate of contraction in consumer demand for the two events:

We have mentioned before that the true severity of any contraction event is the area between the “zero” axis in the above chart and the line being traced out by the daily contraction values. By that measure the “Great Recession of 2008″ had a total of 793 percentage-days of contraction over the course of 221 days, whereas the current 2010 contraction has just reached 766 percentage-days over the course of 273 days — without yet clearly forming a bottom. The damage to the economy is already 97% as bad as in 2008, and the 2010 contraction has lasted 24% longer than the entire 2008 event without yet starting to recover.

We have constructed a new graph to assist in the visualization of the “percentage-days” severity of the two contraction events:

In the above chart the red vertical bar represents the -793 percentage-days of contraction in consumer demand that we measured in 2008. The blue vertical bar represents the same measure (to date) for the 2010 event. But since the 2010 event is not yet over, we have projected the eventual full extent of the 2010 event with the purple vertical bar. That projection is an average of several recovery scenarios, all of which conservatively assume that the bottom has already been reached.

We are keenly aware that many people consider us to be in the lunatic/delusional fringe — all because we simply report current data that has been collected using methodologies unchanged from the ones that tracked 2008 with uncanny accuracy. In early 2009 our “delusions” saw the first signs of the infamous “green shoots” long before more conventional data sources had begun to turn around. We fully understand that our current data has diverged significantly (and for a more extended time) from the conventional “muddle through” vision for the economy. We hope that the “muddle through” vision is correct. But in the meantime we can’t help but wonder who’s delusional.

Thursday, October 21, 2010

Transcript: 408 The Sinking of QE II

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Today on the podcast, Joe Stiglitz, the unintended consequences of the Fed's monetary policy, and the throw of the dice that is QE2. But first this.


Tom Busby of the Diversified Trading Institute

The weak of constitution may want to cover their ears.


There you have it. Gridlock. The recipe for recovery. Even if Republicans sweep, their plan seems to be no plan, so gridlock is all that is necessary.

The Demand Side contention that what business needs is customers is so Twentieth Century. This new economy. Cheap money and foreign exposure are what will make our country prosper, and of course, no regulation. Leave markets to be structured by the big players.


Notes on Meeting with Wall Street

Maggie, transcribe these and distribute them to the inside list

Met with Wall Street at the Regent Park 10:30 AM Attorneys present but not participating

Street seemed to have an elevated notion of its value in the operation, as usual. Began with extended comments on its value to entrepreneurship, business development and capitalization and investor participation.

I indicated that was old news. Previous outcomes were an indicator of poor perrormance. We've busted the model to keep them out of court and out of the red. Humor was not appreciated. Street's performance iven in previous periods was actualized at levels far below promises.

Real economy counterparties fared very badly. Even ignoring the grunts at the household level, which we do, many actors are considering remedial action or legal recourse. Substance is far below claims. Maggie, Get Tom to talk to Research about developing a ... ah ... scenario to explain why the breakdown in mortgage foreclosures is the government's or the grunt's fault. We have to shift liability from Street.

That said. Street is now talking like the managing partner, not the financing arm. This could be bad. For the company. Good thing management does well even when stockholders don't. Street reads it the same way we do. Hang on to the cash until some customers crawl out from under the rocks.

Meanwhile, let the gummint take the hit. We paid them enough.

Street wants us to come in on the retirement question. Not sure about this one. Street sold the 401(k) as the private sector pension plan. Busted. Prospects of replacing social security with stocks are busted. Now the best tack is to replace social security benefits with tax cuts. States and municipalities have pensions are being sucked dry by zero interest. Street says we can have it both ways. Cheap money and renege on the pension contracts. I'm not sure. Tea party anger can only go so far. Street says put some ads on the TV during the football game. It's worked before. Good thing we're not stockholders.


Now from Joseph Stiglitz

Two pieces, one on the domestic situation and another on the international ramifications of Helicopter Ben.


Joseph Stiglitz speaking to CNBC.

Next Stiglitz looks at the unintended consequences of the Fed's easy money. The long-time position of Demand Side is that monetary policy as practiced by the Fed hasn't worked and won't work. Here Stiglitz points to the real effects, destabilization internationally.


Joseph Stiglitz

Outlining the dangers to the international economy.

But backing up a bit, economists on the domestic front have been singularly unimpressed with the prospects for QE 2.0, and many wonder exactly how it is supposed to work. Will bringing down long-term interest rates really dislodge the mountains of cash on the sidelines? Likely not. It's a liquidity trap.

Some say quantitative easing will increase expected inflation. An increase in expectations will what? Increase long-term interest rates, one would think. But we've seen no inflation so far in the Fed's easy money. And we've described the reason. The Fed doesn't control the money supply. Simply printing money doesn't mean it will be lent and leveraged. That needs the prospect of profitable investment. Not present in the U.S. today.

Others say the increase in the price of financial assets will make people feel wealthier and get them to spend. Really? The wealth effect is a difficult one to see when households have taken trillions of dollars off their net worth in the past three years.

Would the Fed buy more private securities, particularly the garbage, that is, the riskier ones? That would be thematic, but no less foolish than the first buy of mortgage backed securities. Anyway, with the audit coming up, the Fed is unlikely to step too far outside its legal authority.

And QE could and probably will cause the dollar to weaken, which encourages exports and discourages imports, presuming other nations watch without matching the move. In fact, dollar weakness is happening, and as we just heard Joe Stiglitz say, it is replete with unintended consequences.

The main reason that QE will work this time is that it has to. The Fed is the only game in town. Ignore past performance. Hope for Papa Ben to make something out of nothing.

In other words, it won't work.

How is the the Hysterical Matron of the Market handling this? We end today's podcast with analysis from Comstock Partners.


For the third time in a little more than ten years Wall Street has embraced a dubious narrative to drive the market higher in the face of crumbling fundamentals. In early 2000 the conventional wisdom discarded over a hundred years of valuation history in denying that the market was in a bubble driven by speculation in internet-related stocks. In late 2007 investors again drove the market to a peak, insisting that the subprime mortgage problem was just too insignificant to impact either the economy or the market. And if anything did go wrong, the good old Fed was there to ensure that the worst outcome would be a so-called "soft landing". In both cases the economy went into a recession and the market dropped more than 50%.

Now, once again the economy is struggling, and investors are depending on the Fed’s impending announcement of QE2 to bail them out, driving up the market in anticipation of the news. That the economy is deteriorating is obvious. If not, QE2 would not even be under discussion. The problem, though, is that after TARP, the stimulus plan, Fed purchases of $1.7 trillion in mortgages and Treasuries, near-zero interest rates, cash for clunkers, homebuyer tax credits, mortgage remodifications and unemployment insurance extensions, there is little more that the Fed can do that they haven’t already done. The Board has used all of its conventional tools and some not so conventional, and now is in the position of entering into a great experiment with unknown outcomes and possible unintended consequences. The truth is that the Fed cannot use monetary policy to force companies, banks and consumers to take credit that they do not want.

The problem was well presented in an August op-ed column in the Wall Street Journal by Alan Blinder, a former Fed vice-chairman and colleague of Ben Bernanke at Princeton. The article, called "The Fed is Running Out of Ammo", outlined three options for the Fed—-expanding the Fed’s sheet further, changing the "extended period" language in the Fed’s statement or lowering the interest rate on bank reserves. He then demonstrated that each of these options had negative political consequences, economic drawbacks or limited effectiveness. He concluded by saying that if the economy didn’t pick up, it would be time to use even this "weak ammunition", although he obviously didn’t think it would be of much help.

Blinder is a main-stream economist, and we doubt that his views differ much from the majority of the FOMC. They must know that they are about to implement a policy that has never been tried before on this scale and that the outcome is extremely uncertain. However, with the White House and Congress in gridlock, the Fed knows that they are the only game in town. What they are hoping to do is increase the Fed’s balance sheet, induce the banks to extend a lot more credit, lower long-term interest rates, spark spending by consumers and business and raise the inflation rate, which they regard as too low.

That from Comstock Partners

The bottom line is that monetary policy hasn't worked, won't work, and can't work. It is demand that is the only way out. Aggregate demand will not be provided by the private sector. The only way out -- public sector spending -- is barricaded by political hacks and economic ignorance. The financial sector has become the economy's master, not its servant. Welcome to serfdom.

Friday, October 15, 2010

Currency and Trade Wars Feed on Stagnation, a take from Nouriel Roubini

Only the Weak Survive
Nouriel Roubini
Project Syndicate
October 14, 2010

The risk of global currency and trade wars is rising, with most economies now engaged in competitive devaluations. All are playing a game that some must lose.

Today’s tensions are rooted in paralysis on global rebalancing. Over-spending countries – such as the United States and other “Anglo-Saxon” economies – that were over-leveraged and running current-account deficits now must save more and spend less on domestic demand. To maintain growth, they need a nominal and real depreciation of their currency to reduce their trade deficits. But over-saving countries – such as China, Japan, and Germany – that were running current-account surpluses are resisting their currencies’ nominal appreciation. A higher exchange rate would reduce their current-account surpluses, because they are unable or unwilling to reduce their savings and sustain growth through higher spending on domestic consumption.

Within the eurozone, this problem is exacerbated by the fact that Germany, with its large surpluses, can live with a stronger euro, whereas the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) cannot. On the contrary, with their large external deficits, the PIIGS need a sharp depreciation to restore growth as they implement painful fiscal and other structural reforms.

A world where over-spending countries need to reduce domestic demand and boost net exports, while over-saving countries are unwilling to reduce their reliance on export-led growth, is a world where currency tensions must inevitably come to a boil. Aside from the eurozone, the US, Japan, and the United Kingdom all need a weaker currency. Even Switzerland is intervening to weaken the franc.

Meanwhile, China is intervening massively to resist appreciation of the renminbi and thus maintain its export performance. As a result, most emerging-market economies are now similarly worried about currency appreciation, lest they lose competitiveness relative to China, and are intervening aggressively and/or imposing capital controls to stem upward exchange-rate pressure.

The trouble, of course, is that not all currencies can be weak at the same time: if one is weaker, another must, by definition, be stronger. Likewise, not all economies can improve net exports at the same time: the global total is, by definition, equal to zero. So the competitive devaluation war in which we find ourselves is a zero-sum game: one country’s gain is some other country’s loss.

The first salvos in this war came in the form foreign-exchange intervention. To diversify away from US dollar assets while maintaining its effective dollar peg, China started to buy Japanese yen and South Korean won, hurting their competitiveness. So the Japanese started to intervene to weaken the yen.

This intervention upset the EU, as it has put upward pressure on the euro at a time when the European Central Bank has placed interest rates on hold while the Bank of Japan (BoJ) and the US Federal Reserve are easing monetary policy further. The euro’s rise will soon cause massive pain to the PIIGS, whose recessions will deepen, causing their sovereign risk to rise. The Europeans have thus already started verbal currency intervention and may soon be forced to make it formal.

In the US, influential voices are proposing that the authorities respond to China’s massive accumulation of dollar reserves by selling an equivalent amount of dollars and buying an equivalent amount of renminbi. Meanwhile, China and most emerging markets are accelerating their currency interventions to prevent more appreciation.

The next stage of these wars is more quantitative easing, or QE2. The BoJ has already announced it, the Bank of England (BoE) is likely to do so soon, and the Fed will certainly announce it at its November meeting. In principle, there is little difference between monetary easing – lower policy rates or more QE – that leads to currency weakening and direct intervention in currency markets to achieve the same goal. In fact, quantitative easing is a more effective tool to weaken a currency, as foreign exchange intervention is usually sterilized.

Expectations of aggressive QE by the Fed have already weakened the dollar and raised serious concerns in Europe, emerging markets, and Japan. Indeed, though the US pretends not to intervene to weaken the dollar, it is actively doing precisely that via more QE.

The BoJ and the BoE are following suit, putting even more pressure on the eurozone, where a stubborn ECB would rather kill any chance of recovery for the PIIGS than do more QE, ostensibly owing to fears of a rise in inflation. But that is a phantom risk, because it is the risk of deflation, not inflation, that haunts the PIIGS.

Currency wars eventually lead to trade wars, as the recent US congressional threat against China shows. With US unemployment and Chinese growth both at almost 10%, the only mystery is that the drums of trade war are not louder than they are.

If China, emerging markets, and other surplus countries prevent nominal currency appreciation via intervention – and prevent real appreciation via sterilization of such intervention – the only way deficit countries can achieve real depreciation is via deflation. That will lead to double-dip recession, even larger fiscal deficits, and runaway debt.

If nominal and real depreciation (appreciation) of the deficit (surplus) countries fails to occur, the deficit countries’ falling domestic demand and the surplus countries’ failure to reduce savings and increase consumption will lead to a global shortfall in aggregate demand in the face of a capacity glut. This will fuel more global deflation and private and public debt defaults in debtor countries, which will ultimately undermine creditor countries’ growth and wealth.

Thursday, October 14, 2010

Taxes and Wealth Distribution, Imagined and Real, from David Cay Johnston

United In Our Delusion

David Cay Johnston | Oct. 12, 2010 09:47 PM EDT

Before reading on, please get out a pen or pencil so you can write down the answer to this question:

What percentage of wealth in America is owned by the poorest 40 percent? Wealth, or net worth, means all property of value, from cash to art to stocks and bonds to homes, minus debts.

Answer: I estimate that ________ percent of wealth belongs to the bottom 40 percent of Americans.

We'll get to the answer, but first, an explanation of the reasons for my question.

Americans are in a fury about taxes, or so the headlines tell us, with Tea Partiers convinced our president is a socialist wealth redistributor who plots to take from the productive to give to the indolent, tax-eating, illegally resident, and nonwhite.

Angry voters are eager to throw out incumbents wholesale in favor of new leaders who promise to slash their taxes, we are told on the broadcast news shows every day.

At the same time, numerous polls that did not make the headlines show that large majorities favor the president's proposal to retain the Bush-era tax cuts on the first $200,000 or $250,000 of taxable income.

When it comes to how wealth is distributed in America, we probably hold radically different views depending on our political affiliation, age, income, and gender, right?

Taxes are central to wealth distribution, or redistribution, as we hear endlessly this election cycle. So it would make sense that people who voted for George W. Bush in 2004 think very differently about the ideal distribution of wealth than people who voted for Sen. John Kerry. People who make a lot hold very different ideas than people who make a lot less, right?

Wrong. We don't think differently. In fact, Americans think very much alike on wealth distribution. Amazingly alike.

High-income or low, Republican or Democrat, young or old, male or female, Bush voters or Kerry voters, Americans are united in what they believe is the ideal distribution of wealth. And they are just as united about what they imagine to be the distribution of wealth in America.

The problem is that neither the ideals we broadly share, nor our estimated distributions of wealth today, bear much relationship to reality.

And therein lies the explanation for how our nation became caught up in such a contentious, nasty, sometimes threatening, and potentially violent debate about tax policy. When it comes to wealth and taxes, the vast majority of Americans are modern Know-Nothings. The disconnect between belief and reality is being exploited by those who laugh all the way to the bank with their tax savings and the burdens they have subtly shifted off themselves and onto the rest of us.

The ideal wealth distribution chosen by the 5,522 people who took the online survey has the top fifth of Americans owning between 30 percent and 40 percent of the wealth.

That means Americans believe the ideal distribution of wealth is that of Sweden. Moreover, 90 percent of Republicans share that belief. (Actually, 90.2 percent, as the survey coauthor, Prof. Daniel Ariely of Duke University, noted when we met to discuss his work.)

The survey sample, with more than 10 times the 504 people often used in polls, is robust and credible. (For the report, see Doc 2010-21608 2010 TNT 196-69: Washington Roundup.)

The genius in the survey was to avoid questions using loaded terms like "estate tax" and "death tax."

Instead those surveyed were shown pie charts and asked what they thought was the ideal distribution of wealth and what they estimated to be the wealth distribution in America. They were not told that one of the pie charts was Sweden's actual wealth distribution, but people gravitated to it like moths to a flame.

What did those surveyed think was the actual distribution of wealth in America?

Figure 1

The actual United States wealth distribution plotted against the estimated and ideal distributions across all respondents. In the "Actual" line the bottom two quintiles are not visible because the lowest quintile owns 0.1 percent of all wealth and the second lowest quintile owns 0.2 percent.

: Norton and Ariely Survey.

They estimated that the top fifth of Americans owns about 60 percent of the wealth.

The reality? Eighty-five percent.

So what about the bottom 120 million of us? Those surveyed said that ideally, the bottom 40 percent would own 20 to 25 percent of all wealth. When asked to estimate the share of wealth actually owned, the collective guesses were between 8 and 10 percent.

Reality: 0.3 percent.

That means Americans think ideally the poorest 120 million Americans should own somewhere between every fourth and fifth dollar of net worth, when in fact they own every 333rd dollar.

John Rawls, the 20th-century philosopher who posed the question about what kind of a world you would like to be born into, influenced the test design. Rawls asked people to think about designing a world in which they had a random chance of being born into any segment. Put that way, most people want the poor to be a lot less poor than they actually are, just in case they are born into the bottom of the economic pile.

So how did you do on the test? What did you write down?

If your guess was on the money -- congratulations! And if you missed by a wide margin -- anything above 1 percent -- don't feel too bad. Prof. Ariely and his coauthor, Michael Norton of Harvard Business School, surveyed two dozen academic economists to check their findings. The pros got it wrong, too, although they did better than the random sample of Americans. The economists estimated the poorest two quintiles owned about 2 percent of wealth, seven times their actual share.

The survey is another example of how scholars not formally trained as economists are showing major flaws in our official economic dogma, neoclassical economics. Instead of assuming everyone is rational and that politically loaded terms like "tax" do not influence what people say, the behavioral economists are trying to understand what goes on inside our heads and hearts when it comes to money.

Ariely holds twin doctoral degrees in cognitive psychology and business. For the 10 years that I have known him, he has consistently identified what trained economists missed, showing blind spots that, like cataracts, cloud the knowledge we derive through the economic lens of neoclassicism.

Ariely sees the world differently because when he was an 18-year-old Israeli soldier, a flare accidentally went off, nearly burning him to death. For months he was motionless in a hospital bed with nothing to do but watch. The first time his feeding tube was replaced with food, he found chewing to be disgusting. The first time he had to take a bath, he did not remember how to get in, settle down, or wash. Today, how people react to seeing his mild facial scars or shaking his mangled hand tells more about them than about him.

Experiences like that help you develop an outsider's eye, just as I find it useful to imagine myself as a cosmic journalist dropped here from another planet who is trying to figure out our ways.

Ariely financed the survey with money he made giving speeches. He spent half on his family and half on research, because no one was funding his behavioral economics experiments and surveys until recently.

To participate in Ariely's latest survey on wealth, go to http://bit.ly/d2WSRg. I'll report the results in a future column.

Mark Mellman, a top Democratic pollster, told a radio audience last week that he thought the poll results showed how American culture is innately interested in fairness. Like Ariely, Mellman was most intrigued by the fact that those surveyed got the ownership share of the middle quintile about right in their estimates of actual distribution. Where people got it wrong was at the top and bottom.

Things were not always this way. Wealth has been piling up at the top, and what little there was at the bottom has been slipping away.

During the 1950s and 1960s, the income -- not wealth, but income -- of the bottom 90 percent grew at twice the rate of those at the top. For the last 30 years, the income growth has all been in the top 10 percent and has been heavily weighted to the top tenth of 1 percent. Big incomes and low taxes help wealth pile up at the top, while stagnant to falling wages and steady or slightly reduced taxes push down the bottom.

So why are so many Americans passive in the face of years of stagnating wages, reduced benefits, and mounting anxiety about whether work will run out before retirement benefits kick in? Why are the better-than-average-income Tea Partiers kicking up a fuss and not the actual poor, the 120 million Americans who own a small fraction of 1 percent of our wealth?

Ariely sees this as a form of learned helplessness.

What's that? "Imagine you have two dogs in two rooms," he said. "One dog hears a bell followed by an electric shock. This dog has a switch he can press with his paw that stops the shock, and he learns to press it when he hears the bell."

The other dog does not hear any bell to signal that the shock is coming and has no switch to turn it off.

"So now you move the two dogs and put them in two new rooms where they can move from one side of the room to the other over a low partition," Ariely explained. "One of the sides of the new room gives from time to time electrical shocks, but if the dog jumps over the partition to the other side of the room, he can escape the shock. When the shock comes, the first dog quickly learns to jump from one side of the room to the other, but the second dog just lies there and whimpers. This is learned helplessness, because when you cannot make a connection between cause and effect, you become depressed and just take it."

Ariely's theory fits with what my unemployed brother discovered. Eric went out on his own last week among his blue-collar friends in rural Oregon to talk about the severe lack of jobs there, the low wages without fringe benefits for those who do find work, and their concerns about the future.

"The people I live with and work with and talk to work at McDonald's or as security guards or on a road crew -- they are high school graduates thinking only about paying their bills and have no idea about politics in this country," Eric told me.

"If you try to engage these people about the state of the economy, just in passing, they have no idea, and they don't care," Eric wrote. "They know bad things have happened to them, they know they can barely pay their bills. They are scared, but they don't know why things have gotten so bad, and they don't know how to find out anything. That's what scares me -- they don't want to find out, because they say knowing won't change anything. They say what they know doesn't matter because they can't do anything about it."

Eric detects a seething anger beneath the surface that the right charismatic figure could ignite. He said when he thinks about this, his thoughts turn to another aspect of the culture he lives in, a macho mix of hatred of taxes and romantic notions about guns, which many of his friends own. "David, do the people you know, the people you talk to, and who read your column, do they understand how scary this is, what could happen?" he asks.

My question is whether we are doing anything to calm the situation and to build a society that not only aligns with our ideals, but that promotes the twin interests of stability and economic growth that benefit all.

What 120 million Americans think, and how they are doing economically, matters. It matters because we are one nation, easily divided. It matters unless you believe Cain was right to deny his duty to Abel.

The interests doling out money for Tea Party events have hired consultants who are superbly talented at exploiting this politically toxic amalgam of helplessness and lack of knowledge about taxes. Add in the racist elements drawn to the Tea Party, and the armed militias whose numbers Time magazine says have tripled since President Obama's election, and there is reason to worry. Doubt that? Google this: Timothy McVeigh hero.

Figure 2.

Below is the actual United States wealth distribution plotted against the estimated and ideal distributions of respondents of different income levels, political affiliations, and genders. Note that in the "Actual" line the bottom two quintiles are not visible because the lowest quintile owns 0.1 percent of all wealth and the second lowest quintile owns 0.2 percent.

: Norton and Ariely Survey.

Ariely sees the ideas of Milton Friedman, the late Nobel laureate in economics, as a major source of the thinking underlying this brooding malaise. I agree and see Ronald Reagan as the popularizer of Friedman's smug ideas.

"Friedman ideology has deeply influenced our beliefs," Ariely said. "Even Obama's statements show this in how he talks about taxes. Americans have this general belief now that government is bad, taxes are bad."

These ideas are easier to market than dandruff shampoo. Taxes, bad. Government, bad. Tax cuts, good. Less government, better.

It is much harder to explain that without taxes there is no wealth, that without taxes there is no civilization, that without taxes criminals take life and property with no redress except violence.

Americans with enough money to buy premium cable television channels saw this tussle between brutish anarchy and supportive communities in the series adapted from Ken Follett's novel Pillars of the Earth. How many viewers connected the concepts to America today?

My previous column, documenting how incomes fell by $2.7 trillion during George W. Bush's presidency, drew thousands of responses on the Internet. E-mails and posts showed how reflexively millions of people react to the words tax, income, and wealth. (For the prior column, see Tax Notes, Sept. 27, 2010, p. 1409, Doc 2010-20557 , or 2010 TNT 186-21 2010 TNT 186-21: Viewpoint.)

Taking their cue from Friedman, even if they do not know who he is or why they believe as they do, many people spout as unchallengeable truth that high taxes are the source of our economic woes, that the Bush tax cuts made us all better off. Hundreds wrote that anything that means less tax money going to Washington is good, missing the fact that less income is bad for them.

As a nation we now know, thanks to Ariely and Norton, that we are united in our ideals about wealth distribution. We share an important value about how the fruits of our society should be spread. Now we need to debate the effects our tax rules have on wealth distribution piling up at the top and draining from the bottom. We need a debate based on facts that appeals to our better natures.

We will probably get past the efforts to use taxes to inflame rebellion just fine. It is unlikely that we will be torn apart by someone mixing fertilizer and diesel, two useful products never intended to be combined into one, unless the demagogues and the oligarchs promoting tax hatred give away matches as Tea Party favors.

Tuesday, October 12, 2010

Transcript: 407X Remarks by Paul Krugman, Jan Hatzius and Martin Feldstein

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The following is a segment of a conversation between three noted mainstream economists sponsored by EPI, CBPP, Demos and the Century Foundation. It took place October 4, 2010.

Presentation: Transcript at http://www.cbpp.org/files/10-6-10bud-panel-02.pdf

That from

Jackie Calmes, New York Times
Jan Hatzius, Goldman Sachs
Paul Krugman, New York Times
Martin Feldstein, Harvard

We offer it for context. As listeners of Demand Side know, our opinion is that the consumer is dead and any attempt to restart the old economy is destined for failure. The capacity utilization problem is not going to be rectified by restarting the old consumer industries. The true capacity utilization problem is labor capacity. That can be addressed most effectively by addressing it directly. The scale of World War II is the right scale. As James K. Galbraith has pointed out elsewhere, it can be spread out over more years. Perhaps a war on climate change?

Other notes. Certainly Depression is the most appropriate term for the long-term high unemployment stagnation these economists describe. Fixing the mortgage problem is now a matter of making the financial sector take write-downs. In itself, it would trigger the need for another bailout or resolution of insolvent banks. We agree that in the political climate we are entering, this is becoming less likely. Finally, the panic which leads to the remedy of throwing everything in huge amounts at the problem, a panic Krugman most clearly expresses, is not the right way. A planned, targeted and massive action is what is needed.

Shumpeter's creative destruction is now called for. The destruction of the financial sector. Its replacement by planned, productive investments guaranteed by the government.


What is QE 2.0?


One of the very best sources on the Internet is the new EconIntersect.  Here Steven Hansen delves the mysteries of quantitative easing.  What is the Fed up to?  Do they even know themselves?

Fed Still Offers No Clues for QE 2.0

Posted on 12 October 2010 by Steven Hansen

The most important aspect of reading the September 21, 2010 Federal Reserve FOMC meeting minutes is trying to get your mind around what they believe – and what they intend to do next.

These formal meeting minutes added little context to the brief meeting statement issued on September 21 which stated in part:

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

It has been the meaning of “additional accommodation” which has been on center stage with talking heads and blogs – and put a fire under the markets and gold.  Most pundits believe Quantitative Easing Rev 2.0 is in the works, with the Fed soon to expand their balance sheet.  Guesses have ranged from expansion of several hundred billion to over $1 trillion.

We now know there was one specific domestic policy directive issued in this September 21st meeting to maintain the Fed’s balance sheet at $2 trillion which stated:

“The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to maintain the total face value of domestic securities held in the System Open Market Account at approximately $2 trillion by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability.”

This was not much of a secret as the NY Fed has announced programs to fill the directive.  But whatever additional accommodation will be still remains a mystery.  There are just a few information scraps thrown about.

Many participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate or if inflation continued to come in below levels consistent with the FOMC’s dual mandate, it would be appropriate to provide additional monetary policy accommodation. However, others thought that additional accommodation would be warranted only if the outlook worsened and the odds of deflation increased materially.

This suggests that the FOMC intends to wait to make any “accommodation” decisions at least until the next meeting.

Meeting participants discussed several possible approaches to providing additional accommodation but focused primarily on further purchases of longer-term Treasury securities and on possible steps to affect inflation expectations. Participants reviewed the likely benefits and costs associated with a program of purchasing additional longer-term assets—with some noting that the economic benefits could be small in current circumstances— as well as the best means to calibrate and implement such purchases.

The FOMC believes in advance that the economic benefits of further QE will be small.  The FOMC continues to remain focused in stimulating aggregate demand (making consumers want to buy).  However, even reading between the lines with magnifying glasses did not offer any clues what accommodation the FOMC was considering.

The FOMC did signal that they were abandoning inflation targets, as well as now targeting GDP growth levels their monetary policy was to achieve:

Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. As a general matter, participants felt that any needed policy accommodation would be most effective if enacted within a framework that was clearly communicated to the public. The minutes of FOMC meetings were seen as an important channel for communicating participants’ views about monetary policy.

So there we have it.  The FOMC will communicate with meeting minutes what they will be doing.  The September 21st meeting minutes communicated nothing except to maintain the decaying Fed balance sheet at $2 trillion.

The uncertainty over the type and amount of Fed accommodation continues.

Sunday, October 10, 2010

David Harvey's Marxian View

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or here is the link: http://www.youtube.com/watch?v=qOP2V_np2c0

Wednesday, October 6, 2010

Transcript: 407 Forecast

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The Forecast Returns,

Karl Popper's line oft quoted by George Soros and replicated on one of the Demand Side blog sites, is,

"Predictions and explanations are symmetrical and reversible." Which is the opposite of the disclaimer which accompanies most private and public forecasts. That disclaimer goes something like, "Of course, economic forecasts are subject to extreme uncertainty."

It is the demand side view that if your explanation is valid, then your prediction will be at least approximately correct. And on the other hand, if your prediction proves to be bogus, then your explanation has to be revisited and revised. It is just not appropriate to blame unforeseeable events. But appropriate or not, this is precisely what the Fed and the fine fellows in the Neoclassical and Monetarist camps routinely do. Most famously, when Ben Bernanke spoke to the assembled at Davos with the words, "Nobody saw it coming," while in the front row were four or five economists, including Joseph Stiglitz, who had been warning of it for years.

As John Maynard Keynes said,

Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be.

No, that is,

I do not know which makes a man more conservative - to know nothing but the present, or nothing but the past.

Well, that's not it either. He said those things, but the one I'm looking for is... Well, I can't find it. Paraphrased, it is "An economists professional standing does not suffer as much from his being wrong as it does from his being outside the consensus view." That is, it is better for one's career to be wrong and close to the norm, than it is to be right.

The hysteria over the next data point evinced in the financial media is generated by the expectation that the next data point will make a difference. Stagnation is in place. This hysteria reveals that forecasters and analysts are not making predictions about the future, they are making predictions about the present. Later in the podcast we will hear from Meredith Whitney on two keys to our outlook -- the downsizing of state and local governments and the fragility of the banking system. Here we will simply note that no recovery occurs without cleaning the financial system of bad loans and recognizing true values of assets. This has not been done, nor is it in prospect.

The Demand Side forecast has been and continues to be bouncing along the bottom, a bottom sloped downward, with increasing fragility in financial markets portending new financial crises. We are adding to our forecast today a bubble watch on commodities. We'll explain that in a moment.

Our chart of GDP continues to be fairly accurate, and even includes the bounce at the beginning of the year. It is drawn at a real rate of one percent. Nominal GDP will be about the same, as inflation continues to be flat. This inflation dimension will be confused by any commodities bubble.

Before we get to that, we have to admit that we overestimated unemployment. We stated that 12 percent unemployment was "baked in," with 20 percent in the all-in U6 measure. So far we've gotten to 10 percent and 17 percent. Some of our error is explained by the shrinking of he work force, and the employment to population ratio continues to describe a very weak economy.

Should Republicans win in the fall, and even if they don't, but are still able to obstruct even modest stimulus or begin an erosion of social insurance, we suspect our 12 and 20 are not unrealistic, at all. Combined with an even greater control of the economy by the casino corporate sector, we will be getting into truly dangerous waters.

Now, the inflation dilemma. New strength in oil markets and a break-out of the CRB Raw Industrials Sub-Index to the upside indicates the cheap chips for the financial sector may be moving into commodity speculation. Over the past ten to twelve years, we have had three major financial bubbles -- the dot.com boom, the housing boom, and the short, sharp boom in commodities ending on July 4, 2008. Each of these bubbles was born out of the efforts to mitigate the damage of the bursting of the previous bubble.

An explicit strategy of Alan Greenspan was to create housing wealth to offset the wealth destroyed in the dot.com bust. At least that was his expressed strategy in 2002. We suspect that after triggering the bust with the historically highest real interest rates in 1999 and 2000, and then attempting to reverse course by dropping them to historic lows, Greenspan observed that the cheap money was flowing into real estate and said, "I meant to do that." A Maestro Magoo, "Ah, Magoo, You've done it again."

Now the reverse has happened, with the bust in housing, interest rates were brought to zero with the idea of stemming the collapse. But that cheap money has flowed into liquid assets, not real estate. True, housing has ended its free fall. Some of this, we suspect, is due to the trillion point two five in Fed purchases of mortgage backed securities and the wholesale takeover of the housing market by the GSE's.

But the point is that the Fed's direct subsidies to the financial sector have not shown up in credit growth, or in housing, but in bonds and stocks. Cheap chips, zero-cost positions, have allowed leverage to dominate these markets. Now it may again be moving into commodities. Note this is a watch, not a warning. Dollar weakness is also a reason for oil price strength. With currencies racing to the bottom, and none getting a lead on the others, it is hard to call which one will win. Be that as it may, the real test will come when the stock market falters. This is when you would expect the chips to get placed on the green, the commodities, to the detriment of all who might eat or use raw materials.

The impact on our forecast is in price rises that may be confused as general inflation. While commodity speculation is a financial phenomenon, it has direct results in gauges of inflation like the CPI, impacts that speculation in housing and stocks and bonds do not. This impact on inflation measures is alarming to the Fed and the inflation fanatics. They have been subdued to some degree by years of price stability, but you can be sure that at the sign of any movement in CPI, they will throw off their restraints and begin the clamor that the long-awaited inflation explosion is at hand, and the sky is finally falling.  Unfortunately inflation as a general phenomenon is far away.

General inflation would mean an increase in nominal wages and salaries, which would reduce the relative burden of debts, whose nominal payments would remain the same.  But earned income is stagnant, except at the highest levels, and fails even to reflect productivity increases.  Thus the increase in prices of commodities is a tax on people that general inflation is not.  Yet the financial authorities are likely to respond with what they view as restriction, because the only response they know to inflation is to restrict demand.

In this case, we may be fortunate, because the Fed's raising interest rates could help.  Pension funds and others who depend on interest income have been starved by the eagerness to coddle the banks with zero interst rates. 

While one might hope for a raise in interest rates, we suspect banking control of Fed policy will not allow this. The response to inflation will likely be seen in the time-honored strategy of shooting ourselves in the foot, with reductions in government spending and investment. Bond vigilantes and inflation chicken littles will demand austerity. Thus, the U.S. will join Europe in starving the ox. Demand will be crippled. The fields that need to be tilled and planted will be neglected, and the Depression will become worse.

Meanwhile the "financial sector first" strategy will continue to gin up demand for financial assets without producing investment.  More and more money seeking fewer and fewer productive uses for money means higher prices for existing assets.  The financial sector, in which we include the Fed, is masturbating and expecting somebody to get pregnant.  It is not going to happen.


That is the Demand Side forecast. Now to the comparisons.


To hear the talk from the professional offices, the current stagnation is nothing but what was forecast by the consensus over the past twelve months. In fact, as we said several weeks ago, since August it has been a sea of people in cardigans and cuorduroy sports coats moonwalking back their predictions. A year ago, ten months ago, eight months ago, six months ago, the number of people predicting something other than recovery was David Rosenberg, Steve Keen, Joseph Stiglitz, and a handful of the usual suspects. For a while it felt like it was David Rosenberg and me. The consensus is coming closer by the week.

The common view and tone is reflected in a piece from Comstock Partners which we will relay in a moment. The irony, the great irony, is that the rehabilitation of Rosenberg and the other heretics comes just at the time the official word came out that they were wrong. The NBER declared the 2007 recession over as of June 2009 and the recovery underway. The response to this announcement epitomizes the situation with forecasters today. Had the NBER made the same statement six months ago, Wall Street and the AEA would have broken out in a mass chorus of "I told you so's." But they didn't, and the response from the same professionals is muted derision, or an embarrassed, "Of course, it doesn't feel like a recovery."

But here, from Comstock Partners, issued August 19, what might be characterized as the lower end of what has come to be the consensus view.

By Comstock Partners

As we have long expected, the economy is tracing out a trajectory typical of a balance sheet induced recession rather than the garden-variety inventory recessions typical of the period since the end of World Wart ll. In a balance sheet recession the dire effects of debt deleveraging overwhelm the efforts of the government to stimulate the economy as is happening now, and the economy undergoes a lengthy period of deflation, sub-par recoveries and frequent slowdowns as the U.S. experienced during the 1930s and Japan over the last 20 years.

While the massive stimulative measures undertaken by the Fed, Congress and the White House have succeeded in averting a financial collapse, they are being more than offset by the deleveraging now taking place. The effects of inventory replenishment are winding down without any other major drivers to sustain growth. Typically a new economic expansion is led by inventories, consumer spending, employment, housing and readily available credit. This time only inventories have performed their usual function, meaning that the economy has been acting on only one of five cylinders.

The Fed has already used all of its conventional weapons and will undoubtedly resort to untried unconventional measures with unknown outcomes and the possibility of unintended consequences. The most likely measures will probably be further large purchases of Treasury securities and mortgage bonds together with a ceiling on Treasury bond yields as outlined in Chairman Bernanke’s famous 2002 speech that earned him the nickname "Helicopter Ben". This is commonly referred to quantitative easing or QE2. We doubt, however, that this will have any more effect than QE1 as it would be more than offset by debt deleveraging.

We also believe that the market is currently too complacent about the global economy. China is attempting to prevent a bubble by engineering a soft landing that will at best result in a substantial slowing of imports, and at worst a full-fledged recession as often happens when governments aim for soft landings. Japan, too, is undergoing renewed economic weakness following two decades of deflation and minimal growth. Europe is going through a short period of temporary calm after the EU and the IMF threw a lifeline to the struggling southern tier. However, the authorities have failed to deal with the underlying structural debt problems that will continue to be a major problem while the austerity measures that that are being implemented will be a major drag on the various economies.

For example the German magazine, Der Spiegel points out that the austerity measures applauded by the EU are already having dire effects on the Greek economy. The Greek government has reduced its budget deficit by an astounding 39.7% and spending by 10%. This has had a drastic effect on income, consumption, employment and bankruptcies, leading to a "mixture of fear, hopelessness and anger". According to the article another wave of layoffs is likely in the fall and this could have" extreme social consequences." Such an outcome could come as a severe shock to a U.S. market that has factored in a quieter Europe.

In sum we believe that the market is still discounting a continued U.S. recovery as well as a supportive global economy. In the current climate such hopes are likely to be disappointed and corporate earnings estimates for 2010 and 2011 will probably be revised down sharply. The market peaked in late April and is now trending down amid a lot of volatility.

That from Comstock Partners

Just in passing,

As we said, our forecast predicts increasing chances of financial crises emanating from the fragility of banks and their exposure to sovereign debt restructuring in Europe and the commercial real estate collapse in the United States. We have also said we are bouncing along the bottom and the bottom is sloped downward. The reason for the downward slope is the decay of the fiscal positions of state and local governments.

Our audio today is from Meredith Whitney, who called the financial sector's collapse to much outrage, only to be proven right. Here are some comments to CNBC recently, relating to both the banks and to the condition of state finances.


Meredith Whitney.

We end today with a note on one of the more notable failures in economic forecasting -- that of Lawrence Summers. Summers arrived in a caravan, preceded by trumpets, promising that a variant of Timely, Targeted and Temporary would return the economy to 8 percent unemployment. The complete failure of this prediction to prove out is probably the major cause of the lapse in confidence for the current administration. Summers returns to Harvard, but the president is left to explain the failure. Now the substantial investment in public goods by government which was the only way out is further than ever from actual public policy.

We are reminded of an observation by Max Planck:  "... scientific truth does not triumph by convincing its opponents and making them see the light, but rather because those opponents eventually die and a new generation comes up that can accept the truth."

Before we all die.

Sunday, October 3, 2010

Rubinomics Defined and Linked


From Bryce Covert
New Deal 2.0
September 14, 2010

What is Rubinomics?

The term is a portmanteau of Rubin and economics, named for Robert Rubin, former Secretary of the Treasury under President Clinton. Rubinomics holds that economic growth can best be achieved by cutting the deficit and balancing the budget. Interest rates lower as inflation fears are quelled, which is then supposed to free up resources for private sector investment. These policies came to mark President Clinton’s administration.

What’s the significance?

This theory stood in opposition to Reaganomics, which holds that the way to spur economic growth is to lower taxes. However, it also goes against more progressive economic theories that advocate government spending on infrastructure, research and development, education, etc. A focus on reducing deficits often crowds out the importance of social investment.

Who’s talking about it?

Marshall Auerback warns against Hillary Clinton taking failed Rubinomics policies from her husband’s administration on as her own…RJ Eskow sees Rubin’s policies lurking in former OMB Director Peter Orzag’s op-ed on tax policy…John Heilemann at New York Magazine reported that Obamanomics were meant as an end to both Reaganomics and Rubinomics…Ezra Klein thinks Rubin’s proteges don’t get enough credit for their flexibility…Michael J. Mandel at Businessweek says Rubinomics and Reaganomics have come to a draw.