Transcript: 367 We're back up with Roubini, Sarkozy and more

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We are back up and running after a somewhat unexpected few weeks off.  We took advantage of the hiatus to finish some other work which hopefully we will be announcing soon.  Thanks for listening.

Today we have notes from and comments on Nouriel Roubini's recent Project Syndicate post, some audio from the Roosevelt Institute's Make Markets be Markets symposium and a continuation of our series on the Sarkozy report.

you will be happy to know that we return as incorrigible as ever.  The recovery has been accepted by acclamation, but the vote only counts at the National Bureau of Economic Research, and they won't be announcing it until after the fact.  Otherwise it depends on economic data, not popular opinion.  Demand Side still sees us bouncing along the bottom.  The business cycle is broken without investment, and there is only a government stimulus program substituting for investment.  The bottom may be higher than in the previous Depression by virtue of the automatic and discretionary stabilizers, but it is still a bottom.  The bad news is they went about fixing things in the first Depression, and we haven't fixed anything this time around.  In particular, we have not dealt with insolvent banks or the mountain of privately held debt.

For a perspective on that, we turn to Nouriel Roubini, now operating from an undisclosed location as Roubini dot com.  He was among the first to see the housing bubble and probably the very first to step out and peg the looming meltdown of the financial sector.  It used to be you could get quite a bit of Roubini.  Now -- at least for non-paying clients -- not so much. 

Here, the first and last paragraphs from a Project Syndicate post by Roubini, entitled.

States of Risk
Nouriel Roubini
Project Syndicate
March 15, 2010

"The Great Recession of 2008-2009 was triggered by excessive debt accumulation and leverage on the part of households, financial institutions, and even the corporate sector in many advanced economies. While there is much talk about de-leveraging as the crisis wanes, the reality is that private-sector debt ratios have stabilized at very high levels."

...

"Unsustainable private-debt problems must be resolved by defaults, debt reductions, and conversion of debt into equity. If, instead, private debts are excessively socialized, the advanced economies will face a grim future: serious sustainability problems with their public, private, and foreign debt, together with crippled prospects for economic growth."

This is the big point.  The problem with demand is it is crushed by debt in the private sector.  Many of these are bad debts.  To be good, they need to be written down.  That is, the lender has to realize risk has two directions.  Absent this, there is no recovery.

In between these two paragraphs, however, Roubini digresses.

"Thus, the recent problems faced by Greece are only the tip of a sovereign-debt iceberg in many advanced economies (and a smaller number of emerging markets). Bond-market vigilantes already have taken aim at Greece, Spain, Portugal, the United Kingdom, Ireland, and Iceland, pushing government bond yields higher. Eventually they may take aim at other countries – even Japan and the United States – where fiscal policy is on an unsustainable path."

"In most advanced economies, aging populations – a serious problem in Europe and Japan –exacerbate the problem of fiscal sustainability, as falling population levels increase the burden of unfunded public-sector liabilities, particularly social-security and health-care systems. Low or negative population growth also implies lower potential economic growth and therefore worse debt-to-GDP dynamics and increasingly grave doubts about the sustainability of public-sector debt."

"The dilemma is that, whereas fiscal consolidation is necessary to prevent an unsustainable increase in the spread on sovereign bonds, the short-run effects of raising taxes and cutting government spending tend to be contractionary. This, too, complicates the public-debt dynamics and impedes the restoration of public-debt sustainability. Indeed, this was the trap faced by Argentina in 1998-2001, when needed fiscal contraction exacerbated recession and eventually led to default."

"In countries like the euro-zone members, a loss of external competitiveness, caused by tight monetary policy and a strong currency, erosion of long-term comparative advantage relative to emerging markets, and wage growth in excess of productivity growth, impose further constraints on the resumption of growth. If growth does not recover, the fiscal problems will worsen while making it more politically difficult to enact the painful reforms needed to restore competitiveness."

Bond market vigilantes are doing nobody any good, not even themselves, except those who win.  These are the casino traders.  They are the masters of the states.  As soon as they are brought to heel, everyone will get back to work.

Side note:  the unfunded liabilities of Social Security do not exist in any meaningful way.  Again, it is the low performance of the economies, which have been run into the ground by the belief that more consumer goods and greater pollution are the route to prosperity, that is the problem.  Reorient economies to bring them into the production of productive goods and the problems disappear.

"... If growth does not recover ..."  Where will growth come from?  Investment.  Where will investment come from?  Not producing more or different types of toothpaste, or even autos and computers, because the demand is being crushed by debt burdens (and plenty of capacity stands idle).  The engines of private investment are blown.  China is willing to create all the industrial capacity the world needs so as to make jobs at $2 per hour. Where, then, is the growth?  It is in the things we need that have been shoved aside for the great free market boom:  infrastructure, climate change technology, education, and so on.

"A vicious circle of public-finance deficits, current-account gaps, worsening external-debt dynamics, and stagnating growth can then set in. Eventually, this can lead to default on euro-zone members’ public and foreign debt, as well as exit from the monetary union by fragile economies unable to adjust and reform fast enough."

Investment, investment, investment.  It does not need to be deficit financed.  Taxing the wealthy, financial transactions, pollution and greenhouse gases.  These bads are being touted as necessary.  With investment in public goods and reductions in private debt, the consumer economy can recover, though not to its previous dominance.  Yes, there will be inflation, perhaps disconcerting spikes of inflation, but we should hope to get there.  The example of Japan is an example of a low-tax, low-social safety net country.  The example of Argentina is an example of doing exactly what Roubini advocates here, following the Washington Consensus.  Avoid Argentina.  Avoid Japan.

Now.

Turning to the recent symposium sponsored by the Roosevelt Institute.  We are going to put up a series of relays from this important event over the next week or so as a kind of grand re-opening event for the podcast.  Here is a sample.

Frank Partnoi

from the Making Markets be Markets symposium.  On the relays you will hear Joseph Stiglitz, George Soros, Elizabeth Warren and others. 

Finally, today, our series on the Sarkozy report.

We last visited the International Commission on the Measurement of Economic Performance and Social Progress on the subject of the shortcomings of GDP as a measure of well-being with the points made in the report that it does not, in fact, measure well-being, but production.  Disposable personal income is a better measure.  Note, income is flat in the U.S.  Now we return with a quote from the report.

"Average disposable income per person is helpful, but gives no indication about how available resources are distributed across persons or households.  For example, income per capita can remain unchanged while the distribution of income becomes less equal.  It is therefore necessary to look at disposable income information for different income groups.  A simple way of capturing distribution aspects is to measure median disposable income, the income such that half of all individuals are above that income, half below.  With increasing inequality, there may be increasing differences between median and average income; a focus on average income does not give an accurate picture of the economic well-being of the "typical" member of society.  Evidence for certain countries, e.g., for the United States shows that median household income as a share of average income fell over the past years, signaling a widening of the income distribution.

A second step toward bringing demography and some distributional aspects into income measures is to follow disposable income per consumption unit or per household rather than per person.  Consumption units are households with an adjustment for their size so that account is taken of the fact that there are fixed costs to running a household.  This adjustment is of increasing importance as the size of the household units changes.  For example, in France real disposable income per person rose at 1.6% per year over the period 1974-2006, but real income per consumption unit rose at 1.3%  Work by the OECD has shown that differences can be even more important in other countries."

The same kind of error is occurring with the savings rate. Obviously in an era of uncertainty, unemployment and excessive debt, people are trying to cut back for personal security's sake.  "Saving for a rainy day," particularly when the storm clouds are so dark.  This is reflected in the savings rate.

But there are many for whom the rainy day has arrived -- the unemployed and financially stressed -- who are drawing down their savings. 

(1) Savings is a function of income; the higher your income, the greater the percentage you save.

(2) A Depression will lower incomes.  The target savings rate will not be the net.  Insofar as incomes continue to decline, or even flatten (total), savings will come under stress.  In a society with wide discrepancies in income, the average savings rate is in some ways meaningless.  The bottom half is struggling to make the rent payment.  The top is cutting back on some discretionaries.

Inevitably in a Depression the savings rate for the majority will have to be lower because they will run out of income.  The top quintile may be saving as never before.

The concern of many is the paradox of thrift.  Of course, this is reflected everywhere, that lower spending reduces economic activity which reduces incomes which then reduces spending further.  It is our view that taxing the upper income brackets will tax savings to some extent and not reduce spending as many imagine.