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Wednesday, January 2, 2013

Transcript: Rollout of ReMacroBaseline.com, fiscal cliff and some notes on Europe

Today, some passing comments on the fiscal cliff, a rollout of our new forecast blog, reMacroBaseline.com, and some notes from Richard Koo and Nouriel Roubini on the prospect for deterioration in Europe.

Our response to the fiscal cliff,

Well, it was nice to see the hysterical matrons of the market in a tizzy and the rest of the country not responding, and once again the Wall Street crowd forced to come up with excuses. But as to the fiscal cliff and the compromise itself?

In this football season, it's like seeing two teams clashing at the 50-yard line, one cheering that they've scored and the other cheering that they've stopped them. Or maybe its more like having a huge argument over how many holes in the hull are best for sea travel. At least there were no announced cuts in social insurance.
Listen to this episode
We are a long way away from stability and recovery, and we have yet to address the crises in jobs, education, infrastructure and climate change. Perhaps most problematic was the expiration of the 2% payroll tax holiday. It will be a hardship, and it needs to be offset by some high multiplier spending, say on infrastructure or aid to states.

But a game-changer? No

We rolled out the Forecast blog yesterday. reMacroBaseline.com. Over the first three months of the year, we hope to establish a comprehensive forecast, one which deals with the popular metrics of GDP, employment and unemployment, inflation, and so on, but is not so obsessed by them that it fails to see reality. The financialization of the economy has skewed economic thinking. The Fed and others think that if only market prices are happy and key metrics are in the green zone, then the economy is doing well. Not the case.

But for the first month we'll deal with those metrics, establish the projections and maybe have a little fun keeping score. In the second month we'll look at the actual condition of the economic world, from climate change to resource depletion and the destruction of the Commons, to investment and infrastructure, energy, transportation, and on into human capital, education, health care, and poverty.
In the third month we have to look at the command structure, the steering mechanism, the predator state, the potential for Democracy to reassert itself, and on into finance, banking and markets.

It's a broad scope, but we think forecasters set themselves too small a task when they focus on the track of certain aggregate numbers, as if these were readouts on dials from a hidden machine, the capitalist economy. There is no hidden machine. There is rampant unemployment, pathetic investment, much too small and not nearly in the right things. In fracking, for God's sake, rather than infrastructure for the future, high capacity transportation, clean energy production and transmission, retrofitting of buildings and massive R&D in non-carbon fuels, in education and health care .

Unemployment, underemployment and mis-employment are the overt evidence of an economy off the rails. the fact that corporate finance and markets have led – or driven – us here means they are blind. The fact that we let them continue to call the shots means we are blind.

And we're going to do the whole thing in 25 words or less. That is, we don't suffer from too little information, but too much, so reMacro will publish only once a week. BUT the scope is broad, so we're going to go through the sequence in subsequent quarters, create a record and hopefully a window big enough to see what is really going on.

Now, we would be remiss not to at least outline the 2013 Forecast, find it at reMacroBaseline.com.

The United States is bouncing along the bottom with downside risks, a bottom that is sloped downward. This has been the forecast for the past three-plus years at Demand Side Economics. Levels of employment and investment dropped dramatically during the Great Financial Crisis and have stagnated since that time. The Obama stimulus of 2009 provided only $250 billion of high multiplier public investment, an impulse that has long since died out. State and local government has become a permanent drag. Monetary policy has actually squeezed real disposable incomes both by depressing interest income and by inflating commodity prices. The fiscal policy debate is now mired in whether to have more or less austerity.

We see no change to public policy that would lead to a substantive recovery. No direct employment programs are on the horizon. The federal government has abandoned states and municipalities to fend for themselves. There will be no meaningful infrastructure spending. (A recent trial balloon for $50 billion in infrastructure would cover about one-fifth of what is needed for simple maintenance.) The climate cliff has happened without arousing any particular interest, and we await the moments of impact -- violent weather, lost resource capacity and permanently damaged natural systems. There will be no meaningful reparations to the middle class, nor a restoration of the egalitarian society which worked so well in decades before the 1980s.

Absent positive contribution from government and caught in its own negative feedback loops, the private sector is destined to drift lower. Investment will be lower. Asset prices will be lower, except as markets are juiced by bubble financing from the Fed. Consumer prices will be lower, again to the extent they escape the Fed's liquidity injections. Personal incomes will be lower. This is the bottom sloped downward.

The combination of easy money for financial players, the tremendous debt overhang in the private sector, and declining real incomes will expose fragile financing structures and lead to further threats of financial crises. Those threats will be met by straightforward debt adjustments or by prolonging the debt squeeze and shifting the pain from the financial sector to taxpayers. Debt adjustments would clear the economy for growth, but are the definition of systemic crisis. Shifting the pain in a way that preserves the current financial architecture exacerbates the inequality, injustice and potential for social disruption. These are the downside risks.

blah, blah, blah,

get that middle section and the charts at reMacroBaseline.com

We put in this rather cute point, however, here:

One last positive, however. The old people. In times prior to the Modern Era and even up through the late part of the last century, elders were leaders who were respected. For good reason. They had seen enough to know and survived enough to have demonstrated intelligence or values. In this early part of the 21st Century, with the retirement of baby boomers, we have an immense number of people with experience, and people with a stake in a working government. It once was said that you were liberal in your twenties and conservative in your fifties, but that was more a description of being co-opted than of aging. Now the boomers find the promises of seven percent gains in stocks year after year as ephemeral as their 401(k)s. Older people will have the time (if not energy) to get involved. And they have at least the opportunity of perspective. To the degree they support the broader interest with their time and talent, and do not become strictly an interest group for social insurance and health care, the power base for reform is set.

What is the forecast?

In terms of common metrics:
• GDP to sub-zero
• Employment in its current stagnant, deteriorating pattern
• Investment lower, both private and public
• Prices lower in real terms
• Easy money creating instability in financial markets
The GDP forecast is condensed to a single chart, which also displays our Net Real GDP, a number which displays the weakness of the private economy by the amount it relies on government deficits.

We have the real GDP number in negative territory beginning in Q1 2013, or really December 2012.

GDP and Net GDP

To engage with traditional forecasts, we need to translate our outlook into common economic parlance, which begin with the measurement of GDP.

Our view is that we scored an eight in the 2008 forecast, as opposed to the orthodox consensus scoring below one. We get credit for not missing the devastating drop, nor overestimating the subsequent rebound. [We, in fact, do not see the recovery at all in terms of the business cycle. The improvement in numbers is not a real economy event, but a statistical event conjured by big federal deficits, easy monetary policy and failure to make the structural adjustments necessary.]

The 2013 Forecasts predicts things on a shorter term, which is the reason for its variability. A flat line extension of both GDP and Net GDP from the 2008 Forecast would be an acceptable alternative. Net Real GDP is lower in our prediction than actual numbers because we anticipated greater interest in infrastructure spending.

But again, remember, even the flat line overstates the health of the economy going forward. GDP is not a good representation of the vitality or direction of a society. Much of the nominal growth is coming in health care, where bad accounting confuses inputs with outputs. And a great deal of economic deterioration is masked by resource depletion, environmental degradation and workforce decay.

Now we end the podcast with a couple of notes.

One from Richard Koo, he of the balance sheet recession, somewhat dated, but still relevant.
The question is how long democracy can survive with governments and EU institutions forcing the patient to undergo treatment for the wrong disease. Eurozone social security programs have made great strides since the prewar era, and as a result a recession will not lead to an immediate collapse of democratic government.

However, the term “democratic deficit” is appearing more frequently in Western newspapers, as more governments are implementing policies without going through proper democratic channels. The complete inability of leaders in the countries already experiencing double dips to present a plan for addressing the situation also casts a shadow over the outlook for democracy.

In Germany’s Weimar Republic, the unemployment rate was at 28% when the government pushed through austerity measures in the midst of a balance sheet recession, causing democratic structures to collapse.

In that sense I am deeply concerned about eurozone unemployment, which now stands at 24.8% in Spain [When Koo wrote this, now over 25% for the first time], and 23.1% in Greece [Now likewise over 25%]. Even more worrying, policymakers have been unable to present the public with a single persuasive scenario showing a way out of the current predicament.

The Weimar Republic collapsed in 1933 after Chancellor Heinrich BrĂ¼ning’s insistence on fiscal consolidation triggered an economic implosion. It is extremely unfortunate that the countries of Europe are repeating his mistake some eighty years later.

The one difference is that this time it is the lack of understanding of balance sheet recessions at the ECB, the EU, and the German government that is pushing the eurozone (ex Germany) in the wrong direction.

The Eurozone’s Delayed Reckoning

Nouriel Roubini
NEW YORK – The risks facing the eurozone have been reduced since the summer, when a Greek exit looked imminent and borrowing costs for Spain and Italy reached new and unsustainable heights. But, while financial strains have since eased, economic conditions on the eurozone’s periphery remain shaky.

Several factors account for the reduction in risks. For starters, the European Central Bank’s “outright monetary transactions” program has been incredibly effective: interest-rate spreads for Spain and Italy have fallen by about 250 basis points, even before a single euro has been spent to purchase government bonds. The introduction of the European Stability Mechanism (ESM), which provides another €500 billion ($650 billion) to be used to backstop banks and sovereigns, has also helped, as has European leaders’ recognition that a monetary union alone is unstable and incomplete, requiring deeper banking, fiscal, economic, and political integration.

But, perhaps most important, Germany’s attitude toward the eurozone in general, and Greece in particular, has changed. German officials now understand that, given extensive trade and financial links, a disorderly eurozone hurts not just the periphery but the core. They have stopped making public statements about a possible Greek exit, and just supported a third bailout package for the country. As long as Spain and Italy remain vulnerable, a Greek blowup could spark severe contagion before Germany’s election next year, jeopardizing Chancellor Angela Merkel’s chances of winning another term. So Germany will continue to finance Greece for the time being.

Nonetheless, the eurozone periphery shows little sign of recovery: GDP continues to shrink, owing to ongoing fiscal austerity, the euro’s excessive strength, a severe credit crunch underpinned by banks’ shortage of capital, and depressed business and consumer confidence. Moreover, recession on the periphery is now spreading to the eurozone core, with French output contracting and even Germany stalling as growth in its two main export markets is either falling (the rest of the eurozone) or slowing (China and elsewhere in Asia).

Moreover, balkanization of economic activity, banking systems, and public-debt markets continues, as foreign investors flee the eurozone periphery and seek safety in the core. Private and public debt levels are high and possibly unsustainable. After all, the loss of competitiveness that led to large external deficits remains largely unaddressed, while adverse demographic trends, weak productivity gains, and slow implementation of structural reforms depress potential growth.

To be sure, there has been some progress in the eurozone periphery in the last few years: fiscal deficits have been reduced, and some countries are now running primary budget surpluses (the fiscal balance excluding interest payments). Likewise, competitiveness losses have been partly reversed as wages have lagged productivity growth, thus reducing unit labor costs, and some structural reforms are ongoing.

But, in the short run, austerity, lower wages, and reforms are recessionary, while the adjustment process in the eurozone has been asymmetric and recessionary/deflationary. The countries that were spending more than their incomes have been forced to spend less and save more, thereby reducing their trade deficits; but countries like Germany, which were over-saving and running external surpluses, have not been forced to adjust by increasing domestic demand, so their trade surpluses have remained large.

Meanwhile, the monetary union remains an unstable disequilibrium: either the eurozone moves toward fuller integration (capped by political union to provide democratic legitimacy to the loss of national sovereignty on banking, fiscal, and economic affairs), or it will undergo disunion, dis-integration, fragmentation, and eventual breakup. And, while European Union leaders have issued proposals for a banking and fiscal union, now Germany is pushing back.

German leaders fear that the risk-sharing elements of deeper integration (the ESM’s recapitalization of banks, a common resolution fund for insolvent banks, eurozone-wide deposit insurance, greater EU fiscal authority, and debt mutualization) imply a politically unacceptable transfer union whereby Germany and the core unilaterally and permanently subsidize the periphery. Germany thus believes that the periphery’s problems are not the result of the absence of a banking or fiscal union; rather, on the German view, large fiscal deficits and debt reflect low potential growth and loss of competitiveness due to the lack of structural reforms.

Of course, Germany fails to recognize that successful monetary unions like the United States have a full banking union with significant risk-sharing elements, and a fiscal union whereby idiosyncratic shocks to specific states’ output are absorbed by the federal budget. The US is also a large transfer union, in which richer states permanently subsidize the poorer ones.

At the same time, while proposals for a banking, fiscal, and political union are being mooted, there is little discussion of how to restore growth in the short run. Europeans are willing to tighten their belts, but they need to see a light at the end of the tunnel in the form of income and job growth. If recessions deepen, the social and political backlash against austerity will become overwhelming: strikes, riots, violence, demonstrations, the rise of extremist political parties, and the collapse of weak governments. And, to stabilize debt/GDP ratios, the denominator must start rising; otherwise, debt levels will become unsustainable, despite all efforts to reduce deficits.

The tail risks of a Greek exit from the eurozone or a massive loss of market access in Italy and Spain have been reduced for 2013. But the fundamental crisis of the eurozone has not been resolved, and another year of muddling through could revive these risks in a more virulent form in 2014 and beyond. Unfortunately, the eurozone crisis is likely to remain with us for years to come, sustaining the likelihood of coercive debt restructurings and eurozone exits.

Read more at http://www.project-syndicate.org/commentary/the-inevitable-return-of-europe-s-crisis-by-nouriel-roubini#yA9lkjlzYLapIvFl.99

Today's podcast brought to you by Demand Side the book, demandsidebooks.com. Find Nouriel Roubini's chapter there. AND by reMacroBaseline.com, developing a forecasting framework for the future of reality.

Suzy Khimm’s summary of the fiscal cliff deal:

— Tax rates will permanently rise to Clinton-era levels for families with income above $450,000 and individuals above $400,000. All income below the threshold will permanently be taxed at Bush-era rates.

— The tax on capital gains and dividends will be permanently set at 20 percent for those with income above the $450,000/$400,000 threshold. It will remain at 15 percent for everyone else. (Clinton-era rates were 20 percent for capital gains and taxed dividends as ordinary income, with a top rate of 39.6 percent.)

— The estate tax will be set at 40 percent for those at the $450,000/$400,000 threshold, with a $5 million exemption. That threshold will be indexed to inflation, as a concession to Republicans and some Democrats in rural areas like Sen. Max Baucus (D-Mt.).

— The sequester will be delayed for two months. Half of the delay will be offset by discretionary cuts, split between defense and non-defense. The other half will be offset by revenue raised by the voluntary transfer of traditional IRAs to Roth IRAs, which would tax retirement savings when they’re moved over.

— The pay freeze on members of Congress, which Obama had lifted this week, will be re-imposed.

— The 2009 expansion of tax breaks for low-income Americans: the Earned Income Tax Credit, the Child Tax Credit, and the American Opportunity Tax Credit will be extended for five years.

— The Alternative Minimum Tax will be permanently patched to avoid raising taxes on the middle-class.

— The deal will not address the debt-ceiling, and the payroll tax holiday will be allowed to expire.

— Two limits on tax exemptions and deductions for higher-income Americans will be reimposed: Personal Exemption Phaseout (PEP) will be set at $250,000 and the itemized deduction limitation (Pease) kicks in at $300,000.

—The full package of temporary business tax breaks — benefiting everything from R&D and wind energy to race-car track owners — will be extended for another year.

— Scheduled cuts to doctors under Medicare would be avoided for a year through spending cuts that haven’t been specified.

— Federal unemployment insurance will be extended for another year, benefiting those unemployed for longer than 26 weeks. This $30 billion provision won’t be offset.

— A nine-month farm bill fix will be attached to the deal, Sen. Debbie Stabenow told reporters, averting the newly dubbed milk cliff.

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