Summary: Team Obama has chosen the soft path to economic recovery. Spend money while stalling any substantial reforms. No confronting our deep structural reforms, just wait for the recovery due later this year. It might work — reliable forecasts are difficult or impossible these days — but its failure would leave us far weaker, making a next round of solutions more difficult.
The Obama Administration’s economic strategy rests on two assumptions:
- The economy will recover sometime in the second half of 2009, and
- If the recovery does not arrive on schedule, then they can take stronger measures.
I believe both are wrong.
Will the economy recover soon? We are on unknown territory, with governments around the world applying fiscal and monetary stimulus on a scale never before attempted (outside wartime). The total stimulus — expansion of the Fed’s balance sheet plus fiscal stimulus — is 17% of GDP. It’s aprox 8% in Europe, and a staggering 26% of GDP in China. (figures from a new report by Nomura). There are few post-WWII precedents for this, so forecasts of econometric models are unreliable.
Jim Grant, editor of Grant’s Interest Rate Observer, put this in perspective:
In {the April 3 issue} of Grant’s Interest Rate Observer, Jim Grant put together a fabulous chart showing the amount of stimulus as a percentage of GDP, both monetarily and fiscally, for this downturn compared to the last 13 recessions. For those, the cumulative monetary stimulus was about 6%, while thus far in this single recession, it has been 18%. In those prior recessions, the amount of fiscal stimulus as a percentage of GDP summed to about 33.2%.
Thus far — and I do emphasis thus far — the government has only ginned up 11.9%, which sums to 29.9% for the combined stimuli, compared to a cumulative total of 39.3% of the prior 13 recessions. When this recession is compared to the Great Depression, the amount of stimulus having been applied so far is almost four times as high, even though thus far GDP has dropped only 1.8%, versus 27% in that collapse.
— The Daily Rap, Bill Fleckenstein, 20 April 2009 (subscription only)
{W}hat is truly momentous is the government’s response. Nothing like it. So there have been 11 recessions/depressions since 1929. On average, the sum of the fiscal and the monetary response as we index them is like 2.9% of GDP. What is shaping up now, in sight and prospectively, is 29% of GDP. Ten times the average response. Now in the Great Depression, before the dawn of Keynesianism, this is three times that response for a recession that is 1/15th the magnitude of the Depression. … They’re probably not done yet.
— Jim Grant, interviewed by Larry Kudlow. Source: transcript of the 15 April broadcast of The Kudlow Report
This is an experiment on a scale never before attempted. In some ways it makes the New Deal look like a cakewalk, a vastly larger stimulus by a far more indebted government. We can only wait to see the results. But if it does not work, then Team Obama can still respond effectively. At least, that is their assumption.
Policymakers are loath to amputate when they might be able to nurse a limb back to health. Some think in terms of reversible error – preferring to take steps that can be revised later if necessary – and there is a general aversion to taking high-risk steps that could do more harm than good. “Governments should practise the same principles as doctors – first, do no harm,” said Mr Obama this month, rejecting pre-emptive government takeovers that could threaten confidence.
An important feature of many policymakers’ thinking is that this is not their last shot – that they are still early enough in the life of the crisis to come back and try again with other, more forceful measures if it does not work.
Still, the administration’s capacity to muster what it takes to intervene decisively could diminish over time. At MIT, Prof Johnson says the politics of bail-outs could get worse rather than better, while Mr Obama’s approval ratings could diminish.
Yet even critics think the administration may get lucky and do just enough to allow the US to muddle through. … “It could all work out – who knows?” says Prof Rogoff. “But there is certainly a chance that what they are doing will end up costing more and prolonging the recession.”
— From “Steeled for stress“, Financial Times, 20 April 2009
This is a reasonable but high-risk strategy. It avoid confronting our deep structural problems, avoids a death-struggle with the powerful financial oligarchs — it’s the safe path that risks destruction. Another possibility is that the this passivity — spending money but otherwise doing little — will allow the rot to spread through the economy. Confidence might diminish, along with Obama’s political capital.
This strategy recklessly burns our financial resources fruitlessly attempting to stabilize the banks. Worse, it squanders Obama’s greatest resource: time. Time is the most important and scarcest resource. Obama needs faster and bolder action now, with reorganizing and recapitalizing the banks as step #1. As Napoleon wrote to Chef de Brigade Coulbert (12 January 1803):
“Go, sir, gallop, and don’t forget the world was made in six days. You can ask me for anything you like, except time.”
For more about this see
- Obama makes his first major policy error, 27 February 2009 — My analysis.
- “Irreversible Damage: Why Little Action on Banking Can Do Great Harm“, Simon Johnson and Peter Boone, New York Times, 23 April 2009.
Afterword
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For information about this site see the About page, at the top of the right-side menu bar.
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about the Financial crisis – what’s happening? how will this end?
- about the End of the post-WWII geopolitical regime
- and some Good news about America, a collection of articles!
Some posts about solutions to the financial crisis:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
- Expect little or nothing from meetings like the G20 – or the Obama Administration, 18 November 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Bush’s bailout plan is now Obama’s. His quiet eloquence guides the sheep into the pen, 30 March 2009
“This is a reasonable but high-risk strategy. It avoid confronting our deep structural problems, avoids a death-struggle with the powerful financial oligarchs. . .” (FM)
A current instance of this is the plan emerging with the “stress tests” to convert bondholders in financial institutions to common shareholders, thus creating the appearance of improved capital positions for the banks. Thus, banks which are technically bankrupt, and should be taken into receivership, are given the illusion of health, in the hope that private money will flow back into them, without the need of asking Congress for more.
Do these shell games reveal a deliberate policy of cheating the taxpayers, or just a lack of competence in the administration to understand what’s really going?
He also said: “In politics, absurdity is not a handicap”. So, no matter how absurd we may think Obama’s policies and deliberations and actions have been or are it is the whim of the voter to decide. Which in perspective has indicated to me that it is the voting public that decided Obama was the real deal who are the absurd.
What really interest me about these types of discussion is the assumption that anyone actually has any clue as to how to stimulate the economy. All these models are simply built on confirmation bias. People see the links between cause and effect they want to see.
The economy is like a patient ill with an unknown disease. Chances are that the patient will recover spontaneously regardless of what anyone does. Stimulus packages are like untested drugs. Some quack barges into the patient’s room and injects them with the drug. Eventually, the patient recovers but no one will ever know if the drug had any positive effect or not.
Think about how hard scientist have to work to figure out what is going on in simple physical systems that they can recreate at will in the lab. Why do we think that we understand much more complex economic systems that we can’t reproduce and can’t test? We have no means of knowing what effect, if any, any economic policy has for good or ill because we have no idea how the economy would have behaved if we had done nothing.
If economics is analogous to medicine, then we are living in the witch doctor age.
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Fabius Maximus replies: What I find odd are comments like this, that assume the massive body of economic data and theory tells us nothing, that the economy has an “unknown disease.” This is clearly false. There is a clear explanation for this problem, described using conventional theory. For details see:
* Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008.
The different pathways out of this valley (“stimulating the economy”) are also understood to some degree. Not well-enough, but far better than “the witch docter age.” For two small snapshots of solutions see:
* A happy ending to the current economic recession, 12 February 2008, and
* A solution to our financial crisis, 25 September 2008
FM: “It avoids confronting our deep structural problems, avoids a death-struggle with the powerful financial oligarchs…”
If you assume the tinfoil hat pose that those same oligarchs _made_ the Obama Administration, then you buy into the premise that they can save it as required. One might find more comfort in the premise that the federal government be empowered to act as referee, but not player in the game of economics. I suppose that these are the “structural problems” to which you refer.
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Fabius Maximus replies: I don’t understand what you mean by “the premise government is not empowered to act as a player in the game of economics”. Modern history shows that free market systems have too much volatility (e.g., frequent depressions, like 19th century US) and produce unpleasant externalities (e.g., unsafe products, monopoly pricing, pollution). Hence the evolution everywhere to mixed public-private systems, in which the government provides regulations and stabilizers. The latter means counter-cyclical intervention to mitigate downturns (i.e., slow the downturn and help people hit by the downturn).
No magic cures, just another set of tools.
FM: “There are few post-WWII precedents for this, so forecasts of econometric models are unreliable.”
Econonometric models, like climatologic models, have no forcasting value whatever and are therefore pure wishful thinking. Anyone who possessed a successful version of either kind of model could invest in ways that would make the Oracle of Omaha look like a piker, and yet somehow, it hasn’t happened! But please, all believers out there, have fun guessing at what’s going to happen.
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Fabius Maximus replies: This is a very binary view, that models work — perfect forecasting — or have no value. It’s not that simple. They represent the current state of the art for economics, and provide a limited ability to explore how different economic dynamics work. Few things in life are all or nothing.
There are reasons to expect the business climate to get worse; that we are in a Bear Market rally which won’t last.
First, the Keynesian economists are in charge of the recovery. They were discredited when the Carter administration had a bad economy, high taxes, low tax revenues, high regulations, high unemployment and high monetary inflation which lead to higher prices. The Keynesian solution of deficit spending and governmental excess could not “put America back to work,” President Reagan did the opposite of everything the Keynesians recommended and the economy recovered.
Next, the Obama administration is betting on the economy recovering without their help, but they are interfering massively in the economy. Partly, their intervention is to reward their cronies and to set up new special interest groups and programs. But, a more substantial portion of their actions is to punish business, regulate it to death, destroy consumer confidence and make it impossible for anyone to plan for the future.
Success will not be rewarded in an Obama administration. Business failures will be propped up by taxation, so that will increase. Risk will not be rewarded, so no risks will be taken. A stagnant economy will follow. And high price inflation is coming.
Finally, practically everything that the Democrats want to implement is wrong headed. They foster profligacy, wastage and sloth, because their interest groups gain from that. Some of this is because it is easier to destroy than to build. Building requires characteristics which are foreign to Leftists. Besides, the left want to punish anyone they might be envious of.
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Fabius Maximus replies: This strikes me as over-heated partisan rhetoric.
* Saying keynesian economics was “discredited” by the policies of President Carter during his 4 years in office is absurd. Economics does not work like that. Most of the economic events in his term resulted from policies of the previous ten years. By the middle of Carter’s term he had initiated many of the policies later known as Reaganomics (e.g., deregulation, and appointing Paul Volker as Fed Chairman).
* Obama’s economic policies (e.g., his bank bailout and stimulus program) are similar to that of President Bush.
* To say definitely that “inflation is coming” is absurd, unless you are some unknown super-genius economist. There are a variety of possible outcomes from this cycle. We are, broadly speaking, following the economic policies of Japan during their 2-decade long struggle with deflation. They did not get inflation, and we might not get inflation.
Well if it doesn’t turn out right, the old ‘Give them a whiff of grapeshot’ may not be advice that the President wants to take… but then we are getting Hanlon’s Razor in action – “Never attribute to malice that which can be adequately explained by stupidity.” Also attributed to Napoleon…
Audacity is great in warfare, wonderful in product marketing and tends to end up with blood on the street in public affairs. Thus the President might need the first and not realize it is due to the second.
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Fabius Maximus replies: I disagree. See this post about the concept of the “golden hour” — originally from emergency medicine, but applicable to many fields. Ling economic downturns consist of cycles, each of which offers a new opportunity for fast, bold intervention.
* High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
The problem that I see is that the stimulus plan won’t have that great an effect on the overall economy. After the money runs out so will the jobs. Hopefully I am wrong.
Remembering Japan’s lost decade of deflation following failure to write off bad loans we seem to be in for much worse.
(1) The Fed has reportedly purchased $1 trillion in private sector debt and has $2.5 trillion in public debt to sell this year. The interest rates required to move their product are likely to balloon despite current thirst for same.
(2) That private hedges might purchase the repackaged bad debt inflating its value only postpones the pain of its eventual loss.
(3) Bankruptcies and foreclosures will continue to climb following unemployment. So I see a descending staircase ahead punctuated by landings on the way.
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Fabius Maximus replies: Let’s take these in sequence.
(1) Perhaps, but probably not. During a recession private investment falls (see today’s GDP news) and savings increases. Both create increased flows into government debt. Esp now, as US portfolio holdings of US Treasuries are extraordinarily low — reversion to post-WWII average levels requires purchases of several trillion in Treasury debt.
(2) Yes, but irrelevant. If it is moved off bank balance sheets and banks successfully recapitalize (I’m skpetical), the economic effect of the future loses by speculators will be minimal. Who cares?
(3) People say this at the depth of every recession, seeing only darkness ahead. Recesions are period of low asset prices, low interest rates, and low rates of investment — a combination which produces its own cure (i.e., purchases of those assets and increased rate of capital investments). Recession come to a natural end. Government’s job is to mitigate the suffering along the way and help fix the structural problems which contributed to the downturn. The question is the magnitude and duration of this recession, the first global recession since WWII.
Report today: GDP down 6.1% in Q1 2009. I predict it’s the beginning. Business owners (i.e. “targets”) should do several things:
1. Refuse to buy, as far as is possible, GE or GM or Chrysler or AIG products and refuse to bank at BOA and CITI.
2. If forced to lay off people, start with the Obama voters (and don’t tell me that because we have secret ballots they aren’t recognizable; most Obama voters couldn’t shut up about him for for months last year).
Obviously don’t announce this, lest you be McCarthyed in front of Henry Waxman or Barney Frank or Chris Dodd or some other godawful politician. If “card check” passes, refuse to do business with union shops. The left seems to want economic warfare, so let’s give it to them, good and hard, where it counts. We can hold out longer than they can, if we starve the beast.
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Fabius Maximus replies: It is bizarre, even absurd, to blame current economic conditions on a President in office for only 100 days. All economic policy actions take months to take effect; most take 6 – 12 months (some longer). Among the fastest actions are the Fed’s changes in monetary policy, which are not under the President’s control.
This reminds me of primative tribes of legend. If the rains don’t come it means the gods are angry, and they require a sacrifice. I hope we are beyond that kind of reasoning.
Re Comment #10: As FM pointed out, Team Obama runs a continuation of the policies instigated by Team Bush at the ‘beginning’ of the crises. So following your logic, layoffs should target those voting Obama in 2008 and those who voted Bush in 2004. For good measure, let’s throw in everybody whose congress representative does not loudly stand against Team Obamas economic policies, because they must be silently aquiesent with their voters tacit approval after all. That leaves a very small workforce, doesn’t it? I am not arguing party politics here, just that your second point is stupidly myopic and in no way helpful.
Your first point on the other hand would be the best way to express public dissent in action, which should be accompained by loud expressions of dissatisfaction at the bailouts.
Just as a thought problem and an entirely different approach to spending trillions:
(1) Abolish the Social Security tax (to put money into workers pockets and help the cash flow of businesses), the corporate income tax (to re-enforce success), and the capital gains tax (help make investment capital more available). Then over a two year period replace the revenue from these taxes — which are basically reflected in the price of goods — with a sales tax, which gradually increases over that time period and as the recovery moves forward. This is not just a stimulus plan but one that would make US workers and businesses more competitive internationally — and done right it will reduce, overall, the cost of living and help increase the standard of living for ordinary workers.
(2) Commit to inexpensive energy going forward rather than huge increases — forced on industry by government — in those costs. This will also help maintain the standard of living for average Americans.
(3) Stop destroying major industries because they lack glamor.
(4) Stop creating officially sponsored, government run, cartels in finance and industry (cartels are bad for us little guys — the little fellows that DC Democrats allegedly care about but actually don’t).
(5) Stop turning CEO’s into government bureaucrats and making political connections more important to success than practical accomplishment.
Just a couple of suggestions. I’m not an economist, obviously.
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Fabius Maximus replies: This is creative thinking. By the numbers…
(1) This would have many ill effects.
* This would make the tax system far more regressive, shifting the cost of government onto the lower income brackets. Saying that rentiers (living off investments) pay no tax on their income, but workers do would be political suicide. Deservedly so.
* What level of sales tax would be necessary to do this? Probably high enough to create massive black markets, in which goods move outside the sales tax system.
(2) What inexpensive energy?
(3) Please give an example.
(4) Good idea. However, since the New Deal the policy of both parties has been to foster cartels — following the golden rule. Those who have the gold make the rules. Nice idea, but who bells the cat?
(5) Please give an example.
To think that government can “stimulate” an economy to a “healthy state” is to ignore the obvious cost of such “stimulus.” Government created economic activity is a zero sum game in that it must be paid for with money from another entity. Private sector economic activity has the possibility to improve the lots of both parties as each recovers additional value from the transaction. Thus, all this stimulus only saddles an unwarranted burden on the public, a burden in the form of debt that will either be paid or inflated, in either case satisfied by the public whether they know it or not. When the inflation “bomb” goes off, there will be no going back. Are you prepared?
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Fabius Maximus replies: On what basis do you make this confident assertion, that is contradicted by the experience of so many countries during the past 75 years?
The error being made is similar to us turning up our thermostat settings to 90 degrees when the house is freezing. We have no intention of letting the temperature reach 90, we just hope setting it so high will make it warm up quicker. Most of us know it won’t warm up any quicker given the finite heating capacity of our furnace, but we do it anyway because it’s human nature to do so.
In Obama’s case, the stakes are much higher, and the costs of such stupidity will be huge. As FM suggests, the answer is not to jam the thermostat up to the max, or stomp the gas pedal down to the floor, or whatever your analogy to massive stimulus is. We all know the plan is to take away the punch bowl, let up the throttle, turn down the thermostat, if and when this starts working anyway to avoid inflation.
The answer is to identify all possible sources of relief, and use them in parallel now, to get ahead of the problem. We need the equivalent of turning on the cook top to augment the furnace, while closing open windows. A big open window is the oligarchs delaying the vicious balance sheet restructuring that is needed right now. The resulting collapse of capital spending, and shut down of new lending we have now is unfortunately very analogous to heat escaping an open window in our freezing economic house.
In response to my comment #10: FM replies: “It is bizarre, even absurd, to blame current economic conditions on a President in office for only 100 days. All economic policy actions take months to take effect; most take 6 – 12 months (some longer). Among the fastest actions are the Fed’s changes in monetary policy, which are not under the President’s control. This reminds me of primative tribes of legend. If the rains don’t come it means the gods are angry, and they require a sacrifice. I hope we are beyond that kind of reasoning.”
I am not totally blaming Obama for our current mess, although he’s responsible for a good chunk of it, and will be more so as we go along.
Many millions of productive people, myself included, are pulling in our horns. We see that we are going to face higher income taxes, higher FICA taxes, higher Medicare taxes, higher state taxes (at least here in IL), higher energy bills due to “cap-and-trade,” higher expenses if we buy something from newly union-shop companies after card-check, probably higher inflation when the effects of all this godawful spending kick in, and on and on and on and on. And we get to pay interest on all the debt for ever, as will our kids and their kids and their kids.
Trillions and trillions and trillions. All so Obama can reward his favored constituents.
I’m already in the 60+% marginal tax bracket (roughly 40% Fed, roughly 15% FICA/Medicare, 3% State [and going up], plus miscellaneous). Then if I want to buy something with the pitiful remnant, we have 10% sales tax around here. What do you reckon is my “fair share,” Mr. Fabius Maximus? 80%? More? I want a specific maximum number.
I’d have to be insane to take on risk right now, borrow money, expand, hire people, etc.
We are not stupid. Markets (and intelligent people) are forward-looking and they know what’s coming, and they are reacting to it. I’ll check back in 6 months and I’m looking forward to reading your handwaving defense of what is shaping up to be a really crappy 2009-2010.
It’s spelled “primitive,” by the way.
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Fabuis Maximus replies: You must be kidding, as if I care about spelling in comments. I’m happy if these are almost intelligible. If WordPress puts in a spell-checker, then I’ll bother.
(2) “I’ll check back in 6 months and I’m looking forward to reading your handwaving defense of what is shaping up to be a really crappy 2009-2010.”
There are 114 posts on this site about the financial crisis. Let’s see if you can find an optimistic note in any of them to support that statement.
(3) “We see that we are going to face higher income taxes, higher FICA taxes, higher Medicare taxes, higher state taxes”
That would be the funnest note of the week, if it were not so sad. Massive deficits run up since Nixon, with a major accellerations under Reagan, Bush Sr, and esp Bush Jr. As of Obama taking office the public debt (from past spending) wass $4.2 trillion, with a liability (past spending plus the present value of future promises) of aprox $65 T. Now you start worrying? Why not at $57 T in 2007, or $40T (whenever that was)?
(4) “We {the American people} are not stupid.”
The numbers suggest that you are wrong. Our descendants will probably agree. For more evidence I suggest that you read We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
Thanks for not telling me the maximum marginal rate I should be expected to pay, as I specifically asked. Typical.
I have been worried about this stuff since the late 1970s. It has taken longer to come to a head than I expected; the resilience of the US economy has been impressive over the decades.
But I don’t think it can take a whole lot more of this. The deficits of the past 40 years, while abominable, PALE UTTERLY in comparison to what’s coming in the next few years. Look at the graphic on Instapundit’s home page right now. Obama’s deficit is going to be WAY WAY WAY WAY WAY more than all the others.
When I said “we,” I did not mean the American people, so don’t add bracketed stuff to my comment. The average American is a dolt. I meant productive, money-making, professional and business-owning people and skilled workers, not the run-of-the-mill goof, who won’t pay attention until he’s starving to death in the street.
People like that are unfortunately susceptible to demagogues of a very bad sort.
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Fabius Maximus replies: This is brutal, probably useless. But I will take a shot at a reply.
(2) “What do you reckon is my “fair share,” Mr. Fabius Maximus? 80%? More? I want a specific maximum number.”
The key is to control spending. It has been spinning out of control of several generations. Ignoring what you order at the diner, instead focusing on how you pay the tab after dinner is a bit … odd.
(3) “Obama’s deficit is going to be WAY WAY WAY WAY WAY more than all the others”
Beware the illusions of specificity. Unlike typical deficits, much of this is generated by loans and purchases of assets. They might be worth less than 100%, but are not zero. This results from the US government running on a cash basis, not an accrual system — which would seperate operating and capital budgets, and include future payments promised today. Excluding these loans and investments, the deficit is probably still a record (suitable for what is probably the worst post-WWII recession) — but that has been the pattern. Each downturn requires a larger stimulus to get the same effect. Like dope.
(4) “The average American is a dolt. I meant productive, money-making, professional and business-owning people and skilled workers, not the run-of-the-mill goof, who won’t pay attention until he’s starving to death in the street”
There is not much to say in reply to this, except to congratulation you on your incredible self-esteem. Us average guys read things like that and think — well, let’s leave this to your imagination.
FM: What level of sales tax would be necessary to do this? Probably high enough to create massive black markets, in which goods move outside the sales tax system.
As if there wasn’t a black market of sorts now in questionable business expenses, offshore tax havens, Subchatper S filings etc! I agree however that the so called fair tax is not the answer. It is too regressive. I propose the following alternative (this is not my idea, it is mostly Arnold Kling’s):
A flat tax on Income and Consumption for individuals and an additional flat tax on Sales and Payroll for businesses – incorporated or not. Tentatively at 8% on each aspect. No deductions. This would make it impossible to escape taxation by doing stupid things like buying lobster for lunch every day and claiming it was a legitimate expense.
To address its regressive nature, each citizen and legal resident alien, including children, would receive a monthly or biweekly rebate check. The size of the check would be such that a family of four living at the poverty level pays no net federal taxes. As this would replace all social spending, we would all be expected to use the rebate check to help pay for necessities like housing, education or health care.
To shift the demand curve in a downturn the government can simply adjust the size of the rebate.
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Fabius Maximus replies: Yes, there are black markets now. But magnitudes matter. A massive increase in US sales taxes might expland these markets so that they become a serious problem.
The spectacle of thieves abetting thieves is hardly unknown territory.
“US portfolio holdings of US Treasuries are extraordinarily low — reversion to post-WWII average levels requires purchases of several trillion in Treasury debt.”
Specious but post-WWII had seen women and some minorities enter the skilled workforce on greeting the returning heroes. The explosion in growth erased the govt. debt with an explosion in revenues.
Your scenario has no similar rescuer. We are exhausting savings to existing debt and new taxes.
“Who cares?”
Investors in hedges, of course. Hedges are ‘contrarian’ by design.
“People say this at the depth of every recession”
US GDP down 6%, ditto German GDP, China? TARP now projected to be $3 trillion, a stealthly $700 billion downpayment on healthcare. The typical sort of recession.
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Fabius Maximus replies: You appear not to understand what “portfolio holdings” means. It is the fraction of private portfolios invested in a specific type of asset (in this case, treasury debt). Holdings of treasuries are low even vs. averages of the 10 years ago, hence re-balancing could require purchase of several trillion more. Also, the US savings rate is rapidly increasing, probably returning to the historical means.
Losses of hedge funds have little macroeconomic effect, which is why I said “who cares”.
Recessions — even depressions (as in GDP decline of 10%+) — are historically commonplace, and they do end. As I have said repeatedly, this is not a typical post-WWII recession. But your comment ignores the normal dynamics that bring downturns to an end.
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Fabius Maximus replies: This strikes me as over-heated partisan rhetoric.
It all depends on what you can correctly predict, FM. Knowing economics is worthless unless you can get a general feel for what the future will bring — cause and effect, you know. My prediction comes down to this: increasing the money supply will eventually result in higher prices (or a lower value for the dollar, which is the same thing.) Deficit spending, as Obama is doing massively, must be paid for either in higher taxes, which will sabotage the economy, increased borrowing, which must be paid back eventually, or by increasing the money supply. Obama is likely to do all three.
The question is whether China will cooperate with Obama’s plans. This seems unlikely. China is trying not to rock the boat as it moves from long term to shorter term US Treasury securities over the next year. If China spooks the bond markets, they lose big time. The Fed is printing money to buy up China’s long term debt, so inflation will come from that, if no where else. How much? It is anyone’s guess. The Fed’s hope is that the economy will revive before the bills come due.
FM: “Saying keynesian economics was “discredited” by the policies of President Carter during his 4 years in office is absurd. Economics does not work like that. Most of the economic events in his term resulted from policies of the previous ten years. By the middle of Carter’s term he had initiated many of the policies later known as Reaganomics (e.g., deregulation, and appointing Paul Volker as Fed Chairman).”
Previous administrations of both parties since the 1930s had adopted Keynesian theories. Only President Eisenhower had a positive budget for one year.
The point is, FM, is that John Maynard Keynes had said that you could manipulate the economy by Fiscal and Monetary policy. That is, when the economy is bad, you could stimulate it by government spending and increasing the money supply. Then, when the price inflation got too high because people were losing confidence in the dollar, you could cutback on these to keep from going into a runaway inflation.
The problem was that the Carter administration had high price inflation in a bad economy (stagflation.) This wasn’t supposed to happen together. Taxes were high in Carter’s term of office but they weren’t producing enough revenue to run the government. Can you see that neither of Keynes solutions would work?
What Reagan did was to cut the increase in the amount of taxes — tax cuts. He had crafted a deal with the Democrat congress to cut spending along with his cutting tax rates, but they reneged on their promises. Reagan’s cutting taxes, even marginally, is totally against Keynes theory. It shouldn’t have worked. The fact that it worked discredited Keynes’ among reputable Economists. The non reputable ones now work for the Obama administration.
FML “Obama’s economic policies (e.g., his bank bailout and stimulus program) are similar to that of President Bush.”
Wrong headed economics can be applied by either political party. Nixon put on Price Controls, for goodness sakes. It did not work to reduce price inflation. Nor did Gerald Ford’s “Whip Inflation Now!” buttons.
You want me to say some bad things about President Bush? Sure, I’d be happy to. What Bush should have done was to let the economy decline in late 2007 the way it wanted to, But Bush could see an election coming up. Putting off the collapse until September 2008 didn’t do the Republican Party any favors, did it?
FM: “To say definitely that “inflation is coming” is absurd, unless you are some unknown super-genius economist.”
You don’t have to be a genius to see the hand writing on the wall. All you have to do is not be blind. Just look seriously at the political mismanagement of the economy in the past–John Law and the South Seas bubble, for instance. There are plenty of other examples. After reading 2 or 3, you can see the pattern developing. Or you can read a little on Smiths and Recardo’s economics. Oops! The schools don’t teach classical economics any more than they teach history. Thus, you are forgiven for being ignorant of these matters.
FM: “There are a variety of possible outcomes from this cycle. We are, broadly speaking, following the economic policies of Japan during their 2-decade long struggle with deflation. They did not get inflation, and we might not get inflation.”
You are assuming that we are following the same path as Japan. It is true that Japan in the 1990s did not allow their banks to write of their debts. Propping up wages and prices prodused stagnation. Japan did simulate their economy through deficit spending. But, Japan never approached the levels of interference in the economy which Obama wants.
Besides, before you reject, as nonsense, any position, shouldn’t you, at least, learn something about it? Rejecting, out of hand, free market economics looks like prejudice. It is not as though the Keynesians have been very successful, so far.
I wasn’t opposed to buying up toxic assets, because that, at least, created a market for them. We do not have a liquidity crisis; we have a trust crisis. No one knows what anything is worth.
But, Paulson didn’t use the TARP funds to buy toxic assets. He gave the money to the banks to prop up their balance sheets. Giving the money to the banks in the absence of a market did no good. All the banks did was to park the money at the FED because they saw no reasonable people to lend money to .
We will recover from this. Getting rid of part of the “Mark to market” rules of the SEC is what gave us the bear market rally. But, this is not over. The more that Obama helps, the worse the markets will be.
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Fabius Maximus replies: There is not much to say here, other than Wheeler knows almost nothing about Keynesian theory, or economics, or economic history. Sorting thru this thicket of mis-information is beyond the scope of a comment. The incredible expansion of the post-WWII era using modern economics (of which Keynes contributed a large part) apparently means nothing to him. The rest is just assertions.
For a more useful look at these issues:
* Consequences of a long, deep recession – part I, 18 June 2008 — What do we do with the excess debt?
* Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008 — A more in-depth analysis of the debt-deflation.
The alternatives are inflation, deflation/defaults, or socialization of the excess debt. Which we will choose, and which we will get (as we all know, these are distinct questions) is far more complex than naifs like Wheeler believe. I suspect some combination of the last two.
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FM note: The max comment length is 250 words. Longer than that will be truncated. Also, no more proposals. Post them on your own blog or write you Congresscritter and newspaper.
As for the politics of my proposed “thought problem” in comment 12 (and thank you for your comments, Mr. Maximus), I remember the 1981 recession (double digit unemployment) and talking to friends who sounded like they would rather be out of a job under a tax system that is “fair” rather than gainfully employed under one that is not so characterized by such intellectual heavy weights as Ted Kennedy and Dan Rather.
The current approach of the Obama Adminstration reminds me of Francois Mitterrand of France — a fair minded man of the left who remade the economy of France into perennial double didgit unemployment rates. Of course Europe has high sales taxes, as oppossed to the Darwinian and predatory USA. I would prefer a straight forward sales tax myself, but if the VAT approach cuts down on black market, then I could tolerate that.
By the way, the Earned Income Tax Credit is a rebate of Social Security tax. Once the Social Security tax is eliminated, it can become a rebate on the sales tax (combined with the 7.5 percent pay raise).
1. So, here is what the proposal would do.
Stimulous: The cash flow of businesses would improve and their labor cost would be lower (the company would no longer pay the SS tax on each worker). This measure really would save jobs by lowering the cost of labor. Workers would get an immediate raise. Instead of a one off check for a few hundred bucks, the workers would have a permanent raise (one that would pay them more if they work more, where the Obama measure will return them less if they work more). The prospect of a sales tax would encourage people to spend their extra money before the taxes kick in, taking up slack in the economy and driving up demand for workers. This would especially apply to durable big ticket items like cars and houses. Housing prices would go up short term, but the prospect of a future sales tax would keep a new bubble from forming (expectations for the resale price would be lower). I know, I know, everyone deserves a villa be given to them. Sorry. Forgot.
Employment: The tax proposals would lower labor cost, but also encourage unemployed skilled workers to accept employment at a slightly lower wage because their take home pay would be the same.
Investment: as demand recovers, businesses would more easily raise capital for investment that would increase worker productivity.
The Sales tax should be introduced gradually over a period of several years. A sales tax would be charged on imports, capturing a revenue source that we currently miss. US made products would be more competitive not just internationally, but in the domestic market. This gives a good prospect for improving the balance of trade and stabilizing the dollar.
The stock market would recover and people’s 401 K’s and other retirement funds along with it.
You commented: Saying that rentiers (living off investments) pay no tax on their income…. I was speaking about corporate income tax, not individual income tax. I’m not proposing the so-called Fair Tax — all though I think the Marginal Income tax rates should be cut and deductions phased out as income increases.
Both the SS tax and the Corporate income tax are generally acknowledged to be passed on to consumers in the cost of the products we buy. So the sales tax would not necessarily boost the over all price level (The direct tax is a visible part of the price — rather than an invisible one) by near as much as you assume.
2. Coal, nuclear, oil.
3. Coal.
4. Right now we are creating new cartels at a dizzying pace — with no one apparently noticing.
5.The Obama Administration basically Sacked the CEO’s of GM and Chrysler. They are determining the compensation packages of others (while heroically standing between them and the mob with pitch forks). In my experience the boss determines how much someone can earn and if you don’t like it you can walk. Of course, private sectors bosses can’t change their mind and take the money back. So perhaps President Obama is more like the Capo di tutti capi — as they might say in certain sections of Chicago — of the entire economy. Whoops. Out of time.
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Fabius Maximus replies: I was speaking about proposal to eliminate capital gains but not income taxes on earned income. How nice that you believe only working people should pay takes on their income. Go to your local factories and preach your message.
FM note: any more of these long comments will be truncated on word 251.
“Fabius Maximus replies: It is bizarre, even absurd, to blame current economic conditions on a President in office for only 100 days. ”
Absolutely true. The financial melt down was decades in the making. But, by responding to it wrongly, a US President can make matters worse. Let’s not talk about Obama to prove that. Let’s talk about Herbert Hoover.
Hoover was Secretary of the Treasury during the 1921 banking panic. He went to President Taft when the stock market bubble broke wanting to intervene, but he could never get President Taft to act until eight months after the ’21 crash. By that time, the markets had corrected. Prices and wages had fallen, so that the boom was on again.
But Hoover was the Republican US President in 1929. He did not have to wait.
Hoover was not responsible for the ’29 crash. The President of the New York Federal Reserve Bank, Benjamin Strong, was. Strong had loaned $50 billion dollars to the Bank of England to prop up its currency after the First World War. This dollar figure was about the same as the deficit after World War One, so the ’29 banking panic should have lasted as long — six to nine months. But, it did not: The bad economy after the ’29 crash did not end for 14 years. Why? Because this was the first time that the Federal government intervened to “help” the economy.
Before this crash, the attitude of the US government was to lessen the burden on the economy by lowering federal taxes and curtailing programs.
Hoover was an interventionist. He had the false belief that high wages and prices were an indication of good times. He acted to prop both up and the result was high taxes and unemployment that never seemed to end. This produced a stagnant economy and interfered with the normal mechanisms for recovery.
What causes a Banking Panic is increasing the money supply. This loose money policy gets lent out to businessmen who are lead into making economic mistakes; they see opportunities where there are none. So, the result of monetary inflation is a business expansion, then a real estate boom and a Stock market boom. The problem is that the capital investment of business did not lead to expected profits, because they were invested in the wrong places. The real estate boom ended when it ran out of suckers as did the stock market crash.
Hoover propped up wages and prices in the capital goods markets, so that the recovery could not take place. Then, he produced a liquidity crisis by shutting down a third of the banks. Even so, unemployment was only about six to nine percent. The real problem came with the protectionist Smoot Hawley tariff act which angered our overseas trading partners. World trade declined and unemployment rose to 16%.
Roosevelt campaigned on getting the government out of the economy, but he carried through with Hoover’s interventionist policies and added new interventions of its own. His expansion of cartels and Trade Union powers increased the unemployment to just under 25% by 1937. But, this interventionist policy was a world wide phenomenon, not just in the US. Benjamin Strong’s propping up the British Pound was just only of many such acts in the 1920s.
Al this is detailed in Jonah Gokdberg’s book, “Liberal Fascism.”
Your reply to Daniel in #13 indicates that you have drunk deeply of Keynesian politics. You are presumptuous in assuming that you have nothing to learn. It’s not as though you will present a good case for your position; you think it is the consensus. Unfortunately, reality will assert itself and prove you wrong. The question is whether you will learn the lesson.
“Fabius Maximus replies: On what basis do you make this confident assertion, that is contradicted by the experience of so many countries during the past 75 years?”
Keynes policies have never lead a country out of its economic problems. It has made them worse, by making the countries ever more socialistic and centrally controlled. You have either have never studied economics or studied the wrong kind. You will have a perfect test case coming up. We will have a stagnant economy all this year. Price inflation will kick in toward the end of the year because of all the loose money due to the bailouts. Obama will allow the Bush Tax Cuts to lapse in 2010, so we will have a double dip recession in 2011. This is already programed in now. But, every interventionist act which Obama or his Democrat cronies enacts from now on can make matters worse.
Not trying to support the post #10 but your response was baloney.
First, he didn’t blame Obama for everything. It’s clear that Obama has taken this recession as an opportunity for economic warfare however. That’s mostly what his post was about. I don’t agree with it however.
Second, political actions can have effects BEFORE they happen. That’s because economics is not physics, and the actors are not particles. Humans, surprise, surprise, are forward looking beings. So for example the effects of the Smoot-Hawley bill were felt before it passed both houses.
Likewise we’ve seen an enormous economic change in the area of gun and ammo purchases. Which happened without Obama “doing” anything. It started happening before he even was elected or took office. All that was required was that there be an increased possibility of his election and democrat stranglehold on congress to cause it.
So markets can and do react far before ridiculous econometric type predictions would expect. Even if played out in the back of ones mind. It’s obvious these silly notions that plague some economists and that you sometimes object to are still nesting in your head.
Also Obama has the power to work on removing all the idiots at the Fed that have been and are currently screwing things up worse.
Obama also came into office in a unique situation. The budget was not set for the first year already like for other presidents. He took this unique opportunity to drive the most irresponsible budget ever seen in the US through congress. People can see that and where it is going and immediately adjust their economic behavior.
“Fabius Maximus replies: On what basis do you make this confident assertion, that is contradicted by the experience of so many countries during the past 75 years?”
Because it’s true. You are interpreting the events in light of the theories you believe. You make the mistake of thinking “experiences” are somehow based on proper interpretation of events.
Keynesians are like the quack doctor that uses some ineffectual medicine and when the patient eventually gets better on his own exclaims “good thing I gave him the medicine”, but if the patient gets worse exclaims, “I got here too late”.
There have been many an economic downturn where nothing was done by the government and things turned around much faster. Example: 1920 downturn. Which you don’t hear about because the prescriptions of the John Law like Keyesian theory were not used. Every time Keynesian type monetary inventions were used going back to before Keynes rediscovered the fallacies of John Law their policies have failed. They make things worse. A perfect example would be the 2001 downturn. Interpreted by Keynesian theory it was a success, but interpreted by Austrian it was an enormous blunder that was bound to cause another bubble and worse crash.
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Fabius Maximus replies: If you believe that mainstream economists are mostly wrong about economics, that’s fine. This site is about geopolitics, not economics. It’s the wrong place to debate fundamental economic theory. That is beyond my capability, and (from what I have seen of your comments) yours as well. I suggest going to economics-focused sites. Many economists have them, and they can respond to your theories. If you have speciific and focused comments, not jeremiads against what you call “keynesian” economics, that is OK. One of the posts about specific aspects of the downturn, such as this about debt-deflation, might be appropriate.
“FM: “There are a variety of possible outcomes from this cycle. We are, broadly speaking, following the economic policies of Japan during their 2-decade long struggle with deflation. They did not get inflation, and we might not get inflation.””
Not true. We are not following their path.
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Fabius Maximus replies: Your statement is far too narrow a description of the article you cite. It should say “We are not following Japan’s path with respect to the money supply.” “Economic policies” refers to a wide range of policies. Most importantly, reforming the finanical system — which most economists’ analysis of debt deflation see as the primary step. Without which monetary growth does little for the economic. For example, see Ben Bernanke’s Essays on the Great Depression (2005). Japan put the banks on life-support, rather than make fundamental reforms (e.g., the Swedish solution of the early 1990’s). So are we.
Also, we are only 3 years into this crisis. Profiting from Japan’s example, we have acted faster and with a different mix of policy actions. They resorted to massive fiscal stimulus progrmams (a step we have not yet taken), eventually running their government debt/gdp from 40% to 185%.
FM: “You appear not to understand not to understand what “portfolio holdings” means”
No, I don’t find your reasoning cogent. China doesn’t either. What interest rates does Argentine debt command?
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Fabius Maximus replies: “Portfolio holdings” is a specific not-very-technical term, your response (#19) to which was the basis for my comment. Your comparison of the US with Argentina is bizarre. The US has a debt to GDP ratio below average of developed nations (albeit rising fast), debt only in its own currency (that alone voids the Argentina analogy), and a 200 year history of financial stability.
As for China, that situation is complex — and I see no basis for your statement that China doesn’t find my reasoning cogent. Here are 3 of the many posts on this site about China’s role in the global financial crisis:
* Words to fear in the 21st century: Lǎo hǔ, lǎo hǔ, Lǎo hǔ, 14 July 2008
* A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
* Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
FM, it is clear that you are beyond reason. I have given you clear signals of what to expect during Obama’s term.
I hope that you will remember them when the stagnation continues, price inflation hits at year end and a double dip recession occurs in 2011 because of the Bush tax cuts being phased out. But, some people are ideologues who cannot learn from reality, no matter how often reality hits them over the head. You seem to fit that mold. I hope you enjoy your poverty brought on by Obama’s Hope and Change. Some of the rest of us will be hunkering down or taking evasive action.
It’s too soon for politics; Obama hasn’t done enough yet to put his popularity in the toilet.
Besides, the Republicans need to agree on an agenda. I favor small government, low taxes, low regulations and getting the FEDs involvement out of the economy. I’d also recommend tossing out everyone currently in public office. This country was founded on citizen participation. It’s time we stopped being governed by experts who serve their own interests.
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Fabius Maximus replies: I admire your self-confidence that you can predict economic developments better than any professional. Why have you not taken this super-ability on the big stage? Fame and fortune await!
Also weird is that you comment on my beliefs without actually reading any of my posts about this crisis (so far as can be seen from your comments), which is perhaps why you so grossly misstate them (BTW, they have proven quite accurate, as such things go). Hint: use quotes to describe my forecasts!
None of this inclines me to take your over-confident forecasts seriously. The sad fact is that reliable economic forecasting is not yet possible.
(1) The data is poor (often some combination of incomplete, inaccurate, and not timely).
(2) Economic theory is immature.
(3) Economic dynamics are driven by people’s choices — which are impossible to accurately forecast. Hence the tentative nature of A-team economists writings (which I find characteristic of top experts in most fields). I emmulate them on this site by sketching out altnerative outcomes, and guessing as to which ones are most likely.
(4) The world changes. Imagine the difficult of doing physics if the speed of light changes over time. Economic structures evolve, so the dynamics change.
Its just said on our radio that 1 in 20 Pound coins are fakes . I’ve just looked at 30 in my till and because the design changes so often , I dont know if they’re fakes or not . Neither will the people I pass them on to .
NGO Quantitative Easing may save us all .
How about we get to the root of the problem? Government keeps going and spending like a drunken sailor. Someway there will always be a problem that requires government to spend our money. First order of business would be to cut spending in government on the high payroll and loop holes were trillions of dollars disappear without any consequences. If they are really serving us the public they won’t mind taking a serious pay cut. Folks I have yet to see anyone even prove that normal citizens are suppose to pay an income tax. People have put up alot of money just to see if anyone could prove it.
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Fabius Maximus replies: Is this irony? Politicians run for office and we elect the folks that promise the most goodies. On what basis do you blame the government? Other than love the mantra of 21st century Americans: It’s Not My Fault!
It is quite apparent that the government is doing things that will cripple this economy for sometime to come. I think they are doing exactly opposite of what they ought to be doing. I would love to drill down and get some real answers.
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Fabius Maximus replies: Do you have any specific examples? “Cripple the economy” seems a bit extreme. We’ve survived the massive series of mistakes made in the 1968-1978 decade, and will probably survive these as well. I hope.
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