from Drudge Report:
In a sobering holiday interview with C-SPAN, President Obama boldly told Americans: "We are out of money."
C-SPAN host Steve Scully broke from a meek Washington press corps with probing questions for the new president.
SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?
OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we've made on health care so far. This is a consequence of the crisis that we've seen and in fact our failure to make some good decisions on health care over the last several decades.
Saturday, May 23, 2009
Obama: "We Are Out of Money"
Friday, May 22, 2009
U.S. Unemployment to top Europe's?
from NYT:
For many years, unemployment in the United States was lower than in Western Europe, a fact often cited by people who argued that the flexibility inherent in the American system — it is easier to both hire and fire workers than in many European countries — produced more jobs.That is no longer the case. Unemployment in the United States has risen to European averages, and seems likely to pass them when international data for April is calculated.
“The current economic crisis,” wrote John Schmitt, Hye Jin Rho and Shawn Fremstad of the Center for Economic and Policy Research, a research organization in Washington, “has turned the case for the U.S. model almost entirely on its head.”
To the contrary. What used to be the U.S. model worked. But we have now adopted the European model over the past two years. Therefore, we should expect similar results -- and we're getting them!
CA Leads Nation In April Job Losses
from NYT:
Forty-four states lost jobs in April, led by California where employers slashed 63,700 positions, as the recession took a further toll on workers.Trailing California in over-the-month job losses were Texas, where 39,500 jobs vanished; Michigan, which lost 38,400 jobs; and Ohio, where payrolls fell 25,200, according to a Labor Department report issued Friday.
California’s unemployment rate was 11 percent last month, fifth-highest in the country. Michigan’s jobless rate was the highest at 12.9 percent, followed by Oregon at 12 percent, South Carolina at 11.5 percent and Rhode Island at 11.1 percent.
As the recession eats into sales and profits, companies have laid off workers and turned to other cost-cutting measures, like holding down hours and freezing or trimming pay.
It's going to get much worse for California, but the defeated tax increases this week will force California to cut payrolls even more!
Stocks Down 9 of Past 12 Days
If it hadn't been for a one-day 200+ point rally, stocks would have been in a solid and confirmed downtrend.
Market Trends and Summary
I sent out this email to friends this morning. It took so long to write that I decided to post it here, too! The charts mentioned are the same ones I posted earlier today on this blog.
I am sending this email to a few select friends who may be curious about what I do for a living and what I see as the major trends at this moment. Most of you have been curious about my trading at some point. Don’t expect me to send this again – it takes too long to write!
I don’t suggest buying/selling anything based upon these charts or this email. This is just what I’m doing as of this moment. I could be wrong! There are other factors and considerations in my trading, also. My trading changes day by day, but these trends appear solid for now. Enjoy reading my musings, if you’re so inclined!
This week, the credit ratings of
Check out the attached charts (see attachments)! Just remember that red means down and green means up (as if it weren’t obvious)! The squiggly lines in the lower panel are volume indicators. I like them because they tend to change direction BEFORE prices do. That’s the closest thing I have to a crystal ball! J
Here are the major trends under way at this moment:
- Plunging Dollar – all major currencies are rising against the Dollar. This should be a concern to everyone because it will cause the price of EVERYTHING to rise. It will cost more $$ to buy the same stuff!
- Inflation – Gold rising rapidly, Crude oil has nearly doubled in 4 months, commodities skyrocketing (see the soybean chart – best bull market this year)
- Debt deflation – treasuries plunging, interest rates rising very rapidly now, accelerating day by day. The price of treasuries just broke through support. This will increase the deficit as the interest costs rise. It will also make debt HARDER to repay for EVERYONE! Ironically, it will INCREASE the likelihood of the
- Opinion: Longer Term, I expect to see unemployment accelerate FASTER as cities, counties, and States are forced to begin cutting jobs due to declining tax revenue.. This is likely to happen this Fall when property taxes are due and the foreclosure market begins to weigh on home prices even more. CA will be faced with this almost immediately – they are in a true crisis NOW. By the way – foreclosures will INCREASE again in 2010 and 2011 as even more mortgages reset just as unemployment reaches 10%!
- More Opinion: I would also not be surprised eventually (perhaps next year) to begin seeing pension funds, including HUGE ones for public employees, unable to meet their promises of paying retiree benefits. This will be precipitated by collapsing muni bond markets as cities and counties can no longer pay their bonds. Watch for municipal bankruptcies to increase late 2009 and early 2010.
- Still more opinion: Within 3-5 years, I expect Social Security and Medicare to implode. Recently, the CBO announced that the SS surplus has declined 95% in the just past 12 months! They’re broke! We are very close to the tipping point with these two programs. The income tax would have to increase 85% -- almost double – just to fund these two programs for current benefits to continue. This is impossible!
I’ve included charts of these immediate accelerating trends (bullets 1-3 above)(read the file names on the charts). These will all hurt the American people -- perhaps badly. Most Americans are clueless that inflation is CAUSED by government. Higher prices are only the manifestation of it. Congress and the Fed get away with it because the people don’t realize that it is caused by THEIR government policies. This morning, Fed Governor Plosser warned of rising inflation ahead because of their policies. HE knows where inflation comes from! Instead, the people will blame the oil cos, grocery stores, manufacturers, etc. for higher prices. The politicians will too, despite that THEIR policies caused the whole mess! They might even impose price control a la Hugo Chavez, but this will cause shortages and make things even worse. Fact: The
One note: Fuel prices, especially oil, will rise strongly in the future. The Cap and Trade tax, (was just approved last night by the Energy Committee in Congress), Obama’s policy of shutting down domestic fuel production, and declining global supplies will cause the cost of energy to skyrocket. This is terrible policy for our economy and our future!
Here is where I am as of today (this changes day by day, of course). These are my current positions:
- Long GOLD
- Long Soybeans
- Short Eurodollar (NOT Forex) (this one is just beginning) (I just reversed from being long). I consider this to be somewhat of a sentiment index. As sentiment declines, so will the Eurodollar futures, which mirrors LIBOR.
- Long Crude Oil (if the stock market tanks, chances are good that crude will also)
- Short natural gas (this one is close to support. I will liquidate soon. Continued economic weakness in industrial sector is destroying nat gas demand.)
- Long all currencies against the Dollar (long Euro, Yen, Pound, but especially the Australian and Canadian Dollars, which are called the “commodity” currencies)
- Short
- Short the US Dollar (I hate to say it, but we’re shooting ourselves in the foot by devaluing our own currency)
- Stocks – only day trade. No long-term position. I expect stocks to collapse again sometime this summer or early fall. Even now, stocks are showing signs of a head and shoulder reversal. Stocks are currently in consolidation. This is NOT the time to buy! This smart money has already exited stocks following the Spring rally. This rally is OVER! Without a fresh breakout to the upside, the risk is to the downside. Remember the saying, “sell in May, and go away!”? It’s true!
Steve
Treasuries Plunge Too, Driving Interest Rates Higher
This will affect every American citizen too, because it will increase the deficit even further! It will increase the likelihood that the U.S. government will have its debt downgraded, as the interest costs of financing the deficit swell even higher as time presses forward!
Is It Any Wonder That the Dollar Continues Its Plunge?
The 16-nation euro rose to $1.4015 in morning trading from $1.3889 in New York late Thursday—its first time above $1.40 since Jan. 2. The British pound rose to $1.5916 from $1.5890, peaking at $1.5945 earlier in the session, its highest point since Nov. 6. 
The Dollar has continued its plunge overnight and this morning. It looks like it's in freefall!
Daily chart also:
from AP on Breitbart:
The dollar kept falling Friday, notching fresh multimonth lows against the euro, pound and yen as a warning that Britain's debt level may result in its credit rating being cut ricocheted into worries about the massive U.S. deficit.
Fed's Plosser Warns of Coming Inflation Risk
from Bloomberg:
Federal Reserve Bank of Philadelphia President Charles Plosser said prices may rise 2.5 percent in 2011, a rate well above central bankers’ preferred range, and cautioned against complacency on inflation.“The economy may be at greater risk of inflation than the conventional wisdom indicates,” Plosser said in a speech yesterday in New York. “While inflation expectations appear to remain anchored, we should not become sanguine about our credibility. It can be easily lost.”
The bank president’s inflation forecast for 2011 exceeds central bank officials’ long-run preferred range of 1.7 percent to 2 percent, and contrasts with the concerns of some officials and economists that the economic slump may provoke a broad decline in prices.
For the Fed I have some news: Inflation is already rising. Crude oil has risen 85% since its lows just 3 months ago. Soybean prices have risen 40% off its lows. These prices are typical examples of what has happened to commodity prices since the beginning of this year! The government's PPI and CPI indicators are lagging indicators of about 6-9 months. Just watch the commodity indexes to know where the market is predicting that inflation will go.
Another Bank Bites the Dust
This one is significant because the government didn't wait for the weekend to carry it out. This can only be explained as a sign of desperation. From My Way News:
The federal seizure of struggling Florida thrift BankUnited FSB is expected to cost the Federal Deposit Insurance Corp. $4.9 billion, representing the second-largest hit to the FDIC's insurance fund since the financial crisis began felling banks last year.
CA Bugdet Gap to Be Closed By Forced "Borrowing" From Its Local Governments
from WSJ:
California Gov. Arnold Schwarzenegger, in his efforts to find funds to balance the state budget, has proposed borrowing $2 billion from municipal governments over the next fiscal year, a tactic that is rankling local officials up and down the state.I have news for you, Governor Schwarzenegger. Forced lending is not borrowing. It's stealing! It's confiscation!Mr. Schwarzenegger is invoking a 2004 law that lets the state demand loans of 8% of property-tax revenue from cities, counties and special districts. Under the law, the state must repay the municipalities with interest within three years.
Administrators of already cash-strapped cities and counties said the loans would force even deeper cuts in services. Fewer cops and fire engines would be on the streets, they said, and parks and libraries would be closed more often. And some local governments would be forced to lay off workers to keep their budgets out of the red, they said.
Mr. Schwarzenegger's proposal "suggests that financing state government and state-government services are more important than these basic community services," said Chris McKenzie, executive director of the League of California Cities. "I think it's something most of the public would disagree with."
More Debt Worries Continue to Sink Dollar
from Bloomberg:
Treasury Secretary Timothy Geithner committed to cutting the budget deficit as concern about deteriorating U.S. creditworthiness deepened, and ascribed a sell-off in Treasuries to prospects for an economic recovery.“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television yesterday. He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year.
The dollar extended declines today after Treasuries and American stocks slumped on concern the U.S. government’s debt rating may at some point be lowered. Bill Gross, the co-chief investment officer of Pacific Investment Management Co., said the U.S. “eventually” will lose its AAA grade.
Unfortunately, the Treasury Secretary has little credibility when the White House' actions contradict its teleprompter speech. Talk is cheap! Actions speak louder than words!
Thursday, May 21, 2009
Climate Talks Amount to Bunch of "Gas"
from Marketwatch:
China is taking a tough line ahead of key climate talks next month, demanding heavy cuts for other, richer nations and payouts to itself, according to a Japanese news report Friday.
The Nikkei report cited official Chinese statements Thursday calling on wealthier countries to cut greenhouse gas emissions 40% by 2020 from 1990 levels, and help pay for reduction schemes in poor countries, according to a published report.
China also repeated its position that developing countries -- including itself -- should only curb their emissions on a voluntary basis, and then only if the curbs "accord with their national situations."
Formal climate-change negotiations are slated to begin on June 1 in Bonn, Germany.
China's argument that developed countries should be legally required to give at least between 0.5% and 1% of their annual economic worth to help poorer countries curb greenhouse gas emissions isn't likely to be warmly received by the U.S. and European Union, the report noted, citing analysts as saying the position may just be posturing ahead of the negotiations.
The Chinese government has estimated it would need to spend the equivalent of $146 billion per year to curb its greenhouse gas emissions, the report said.
Also:
Members of the House Energy Committee on Thursday approved a sweeping bill aimed at arresting climate change, the first step in a potentially enormous re-ordering of U.S. energy policy.
By a vote of 33 to 25, members approved language cutting carbon emissions by more than 80% below 2005 levels by 2050 through a "cap-and-trade" system. The bill would also boost use of renewable energy and set new targets for energy-efficient buildings.
The Year of the Soybean
I noticed on Farm Futures' website today, they had an article entitled, "Is This the Year of the Soybean?" By the charts, apparently so. That is some bull! Export demand continues strong, with sales last week amounting to five times the average volume for this time of year!
Dollar Continues Downward Path As Debt Worries Rise
from Reuters:
The dollar on Thursday plunged to its lowest level this year against major currencies, and the euro approached a five-month high above $1.39 as worries about swelling U.S. deficits soured investors on U.S. assets.
Standard & Poor's announcement that it could downgrade Britain's triple-A credit rating initially weighed on sterling. But Pacific Investment Management Co's Bill Gross said fear the United States may face the same predicament slammed the dollar and drove the 10-year Treasury yield near a two-week high.
"No one wants to admit it but there might be investors nervous enough with the extreme levels of indebtedness of the U.S. government so that just the thought of a downgrade would provide an excuse to sell dollars," said Matt Esteve, a trader at Tempus Consulting in Washington. "If such a thing happened, the impact would be huge."
The U.S. Treasury on Thursday said it would sell another $101 billion in notes next week. [ID:nN21559422]
The euro was up 1 percent at $1.3899
S&P's warning on the UK initially lifted the dollar by some 3 cents against sterling, but the pound recovered and hit a 6-1/2-month high near $1.59 before easing back to $1.5861
Days Following Strong Momentum Days
from Dr. Brett--
Monday, we saw Demand--an index of the number of stocks closing above the volatility envelopes surrounding their short-term moving averages--exceed 190, while Supply (an index of those closing below their envelopes) was only 19.
Going back to late 2002, when I first began collecting these data, we've only had 31 days in which Demand has exceeded 180. That typically occurs after breakout moves, when many stocks display favorable upside momentum.
Interestingly, returns over the subsequent five days in the S&P 500 Index (SPY) have not been favorable. The average five-day change following a big upside momentum day has been -.82% (14 up, 17 down). Nor have returns been favorable 1-4 days out.
It appears that there has been no short-term bullish edge following large upside momentum days, with profit taking not uncommon.
Additional Comment 7 AM CT - I notice that the excellent Market Tells and Quantifiable Edges newsletters--both of which feature historical trading patterns--arrive at somewhat similar conclusions to the above, but each of them goes into more depth, with additional findings. Hats off to these worthwhile resources.
Note: Demand and Supply are proprietary measures; they're updated each morning prior to the open via Twitter (follow here).
Losing Money Correctly
from Dr. Brett--
So much of trading success comes from learning how to lose the right way. If many of the traders I work with followed a few basic guidelines about losing well, it would aid their performance immeasurably:
1) Never lose so much on a single trade that you can't come back and be green for the morning or afternoon;
2) Never lose so much in the morning that you can't battle back and be green for the day;
3) Never lose so much in a day that you can't rally and finish the week green;
4) Never lose so much in a week that you can't have a profitable month;
5) Never lose so much in a month that you can't make money for the year.
2) Never lose so much in the morning that you can't battle back and be green for the day;
3) Never lose so much in a day that you can't rally and finish the week green;
4) Never lose so much in a week that you can't have a profitable month;
5) Never lose so much in a month that you can't make money for the year.
Psychologically, it's healthy to experience defeat and then overcome it. It strengthens you to battle back and win. If you lose the wrong way--by taking so much risk that you can't come back for the day, week, month, or year--you rob yourself of the victory that could be yours by going from red to green.
Sound risk management is the cornerstone of a healthy trading psychology.
Long Slog to Recovery -- Fed Says 5-6 Years!
from Reuters:
Data on Thursday underscored that economic recovery in the United States will be a long, slow slog, with a key manufacturing indicator showing only marginally less weakness and an outlook for rising unemployment even when growth resumes.
The new reports came a day after the Federal Reserve, in minutes released from its April policy meeting, cuts its outlook for economic growth over the next three years and said a full recovery could take five or six years.
The Federal Reserve Bank of Philadelphia on Thursday reported that its closely watched indicator of factory activity in the Mid-Atlantic region was marginally less weak in May, while an index of leading economic indicators for April managed its first increase in almost a year.
The Labor Department reported that initial jobless claims last week fell for the third time in four weeks. But the labor market outlook remained cloudy, with the Congressional Budget Office projecting that the unemployment rate could rise even when economic growth resumes.
"The Philly Fed data was definitely on the disappointing side of expectations," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut. "The numbers are consistent with only a tepid global recovery as factories switch on the lights again."
Greenspan: It's Not Over Yet
Greenspan's comments are assisting in sending stocks south. From Bloomberg:
“There is still a very large unfunded capital requirement in the commercial banking system in the United States and that’s got to be funded,” Greenspan said in an interview in Washington. He said “until the price of homes flattens out, we still have a very serious potential mortgage crisis.”
Strong Fundamentals Push Soybeans Higher
We continue to set new records almost daily with soybeans despite weakness in the broader markets. I think we may be setting up for a correction for soybeans. This is beginning to feel overbought to me!
Natural Gas Plunges From Its Peak
Worries of a weak economy is causing demand worries. Daily (left) and 4 hr (right)
Stock Market Sell-Off Turning Into Stock Market Rout
The Dow is now down nearly 150 points on strong volume today!
Fed Not Convinced Stabilization Will Last
from Bloomberg:
Federal Reserve officials, who see possible signs of “stabilization” in the U.S. economy, signaled they’re not convinced those improvements will persist.
Policy makers, meeting April 28-29 in Washington, saw “significant downside risks” to the outlook for the economy, with the global financial system still “vulnerable to further shocks,” minutes of the session released yesterday said.
The report indicates that Fed officials may be ready to build on their plan in March to buy $300 billion of Treasuries should the economy or financial markets deteriorate further. Some policy makers said an increase “might well be warranted at some point to spur a more rapid pace of recovery” from the worst recession in five decades, the minutes showed.
Standard and Poors: UK Close to Losing AAA Rating
from Bloomberg:
Britain may lose its AAA credit rating for the first time as government finances deteriorate in the worst recession since World War II.
Standard & Poor’s lowered its outlook on Britain to “negative” from “stable” and said the nation faces a one in three chance of a ratings cut as debt approaches 100 percent of gross domestic product. The pound fell the most in four weeks against the dollar, the FTSE 100 Index slid as much as 2.8 percent and the cost of insuring U.K. debt against default rose.
Weekly Jobless Claims Eases Modestly, But Also Sets New Records
I always find it amusing that NBC News and its affiliates always tries to spin the continued worsening of joblessness in this country as a positive now that a left-wing zealot occupies the White House, despite that there is no significant improvement yet. Here is the press release from Bloomberg, which includes both the "good news" and the "bad news":
More Americans than forecast filed claims for unemployment insurance last week, and the total number of workers receiving benefits rose to a record, signs the job market continues to weaken even as the economic slump eases.While this past week's jobless claims were slightly lower than expected (good news), the previous week's claims were revised higher (bad news) and the total number of unemployed continues to rise (even more bad news). To me, the bad news continues to outweigh the "green shoots" of good news, but NBC continues to intentionally distort and spin the news in favor of its bed partner, the Obama Administration.Initial jobless claims fell by 12,000 to 631,000 in the week ended May 16, from a revised 643,000 the prior week that was higher than initially estimated, the Labor Department said today in Washington. The total number of people collecting benefits rose to 6.66 million, a record reading for a 16th straight week, and a sign companies are still not hiring.
Job losses are likely to continue after Chrysler LLC filed for bankruptcy and General Motors Corp. may follow suit and terminate 1,100 U.S. dealers. The auto slump threatens to slow any recovery from the deepest recession in half a century and keep pushing unemployment higher.
“We expect upward pressure on claims stemming from auto- related layoffs,” said Maxwell Clarke, chief U.S. economist at IDEAglobal in New York, who acurately forecast the initial claims number. “The labor market will remain weak, with gradual improvement on the horizon.”
Tough Love: The Fed Says "No" to California
The Federal Reserve has refused the State of California's request to guarantee the state's bonds. This is an unexpected surprise! California has the worst credit rating of any state in the country, and the idea of extended the U.S. government's credit rating (which is also sinking fast) and protection to the most profligate state in the union is not appealing to most of the other citizens in the country. Perhaps the Fed's decision is one of expedience; by extending protection to California, the Fed would simultaneously risk sacrificing the credit rating of the entire country for political expediency.
Let California sink or swim! Let them live with the consequences of their over-spending and the prostitution of their reputation!
It's Not Coincidence. It's Correlation!
It's not an accident that during this recession, the states with the highest unemployment rates and largest deficits are the states that also have the highest taxes. This is not coincidence. It is correlation!
This has been proven again and again for countries as well. Europe has historically had higher taxes than the United States, with their cradle-to-grave welfare states, but they have also historically had unemployment rates significantly higher than the United States. This may be changing, however. With the United States substantially shifting its tax burden, and increasing both its debt load and its welfare spending, it will suffer the same fate: crushing tax burdens on its citizens, and chronically-high unemployment! That is not a prescription for prosperity! It's a formula for economic malaise!
Wednesday, May 20, 2009
Playing Dollar Dominoes
from financialpost.com:
The U.S. dollar's day of reckoning may be inching closer as its status as a safe-haven currency fades with every uptick in stocks and commodities and its potential risks - debt and inflation - are brought under a harsher spotlight.
Ashraf Laidi, chief market strategist at CMC Markets, said Wednesday a "serious case of dollar damage" was underway.
"We long warned about the day of reckoning for the dollar emerging at the next economic recovery," Mr. Laidi said in a note.
Mr. Laidi said economic recovery would weigh on the greenback as real demand for commodities, coupled with improved risk appetite, caused investors to seek higher yields in emerging markets and commodity currencies. This would draw investment away from the U.S. dollar, which was dragged down by growing debt and the risk quantitative easing would eventually spark a surge in inflation.
The U.S. dollar slid against most major currencies Wednesday, hitting a five-month low of US$1.3775 against the euro and pushing the Canadian dollar up US1.21¢ to a seven-month high of US87.69¢.
John Curran, the senior corporate dealer at Canadian Forex, said the U.S. dollar would likely fall further in the next week, with the Canadian dollar likely reaching about US88.35¢, at which point it could break higher to test the US92.35¢ level.
"The U.S. dollar is continuing to slide as investor appetite is gaining momentum," Mr. Curran said. "People are getting comfortable about taking on a little more risk."
The rise in the Canadian dollar has moved in lock-step with the improvement in equity markets since March 9. Over this time, the S&P 500 has risen by 34%, the S&P/TSX composite index has gained 35% and the Canadian dollar has increased by 14%, equal to almost US11¢. Since Feb. 18, light-crude oil has risen by 46% to US$62.12.
But as risk appetite and equities improve, Mr. Curran said it was unlikely the U.S. dollar would embark on a long-term decline.
"While things are beginning to thaw, it doesn't mean it's full-on summertime just yet," he said. "A lot of people are looking for the Canadian dollar to strengthen dramatically again towards par. I'm not sure about that just yet."
Nevertheless, concern has been mounting that the increasing U.S. debt load, as well as a potential inflation time bomb in the form of the quantitative easing, could drag down the greenback. Garnering attention is the risk the United States could lose its triple-A sovereign credit rating, which reflects the chance of the borrower defaulting on its debt.
"By many measures, the U.S. appears just a few short steps away from losing its coveted triple-A status, unless the recovery turns out to be considerably stronger than expected and the fiscal repair is faster than commonly expected," said Douglas Porter, deputy chief economist at BMO Capital Markets. "A downgrade could boost the cost of funding U.S. debt at the margin, but underlying inflation and fiscal fundamentals will ultimately be the primary driver."
Despite the risk, Paul Ashworth, chief economist at Capital Economics, said the United States was unlikely to lose its rating. But, in the event of a downgrade, he said it would probably not have a lasting impact on the U.S. dollar.
However, he said a big threat lurked in the country's expanded monetary base, which now stands at about US$1.8-trillion. While the expanded monetary base was needed to feed economic growth and ward off deflation under the Fed's quantitative easing plan, Mr. Ashworth said such high levels could fuel rampant inflation once broader monetary conditions improved.
He said it remained to be seen how much success the Fed will have when it decides to end its quantitative-easing plan and shrink the monetary base.
Stocks: Showing Signs of Sinking
The stock index futures continue to show signs of weakness, especially on the volume indicators.
Going For Broke: Pension Funds Seek Relief In Chrysler Bankruptcy
from FT:
Three of Chrysler’s secured creditors are mounting a fresh attempt to thwart the carmaker’s Chapter 11 reorganisation on the grounds that it violates their legal rights and the US government’s authority under the Troubled asset relief programme.
The three – all Indiana state pension funds – are among a group of 46 creditors that had appeared to back away this month from efforts to derail the process under which a “new” Chrysler would emerge from bankruptcy protection by July 1. The new entity would be owned by a union healthcare trust, the US government and Italy’s Fiat.
Chrysler, with backing from the US Treasury, had offered its secured creditors just under 30 cents on the dollar to settle claims totalling $6.9bn. Four big banks, holding the bulk of the claims, accepted the offer following political pressure from Washington.
However, the Indiana State Teachers’ Retirement Fund said on Wednesday that it had a fiduciary responsibility to its members to continue the fight. The fund stands to lose $4.6m under the current settlement proposal and has teamed up with Richard Mourdock, Indiana state treasurer, to try to recover those losses.
The latest objections could galvanise other lenders to renew their challenge. “I fully support their motion and believe a number of lenders (including us) will ultimately join their group,” said George Schultze of Schultze Asset Management, one of the creditors that had abandoned an earlier legal fight.
In a court filing on Wednesday, the Indiana funds accused the government of adopting a strategy of “the ends justify the means”.
They also said the Treasury “has taken constructive possession of Chrysler and is requiring it to adopt a sale plan in bankruptcy that violates the most fundamental principles of creditor rights – that first-tier secured creditors have absolute priority”.
The Indiana funds say the current plan will strip their collateral into the new company, benefiting more junior creditors. The funds also allege that Tarp funds were meant to be funnelled only to financial institutions.
Fed Notes: Uh, It's Worse Than We Thought
from CNN Money:
The Federal Reserve's latest forecasts for the U.S. economy are gloomier than the ones released three months earlier, with an expectation for higher unemployment and a steeper drop in economic activity.
The Fed's forecasts, released as part of the minutes from its April meeting, show that its staff now expects the unemployment rate to rise to between 9.2% and 9.6% this year. The central bank had forecast in January that the jobless rate would be in a range of 8.5% to 8.8%, but the unemployment rate topped that in April, hitting 8.9%.
The Fed also now expects the gross domestic product, the broadest measure of the nation's economic activity, to post a drop of between 1.3% and 2% this year. It had previously expected only a 0.5% to 1.3% decline.
FOMC Notes: More Fed Dead -- Er, Red -- Ink
from WSJ:
Some Federal Reserve officials are open to raising the amounts of mortgage and Treasury securities purchase programs beyond the $1.75 trillion that they have already committed to buying, according to minutes from the Fed’s April meeting.
Officials, meanwhile, projected an even deeper recession than they expected three months earlier and a more sluggish recovery over the next two years as labor markets remain under pressure.
“Some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery,” according to the minutes of the April 28-29 meeting, released Wednesday with the usual lag.
Grains Reach New Highs, But Can't Hold Them
Strange trading, because while corn, wheat, and soybeans all reached new 2009 highs today, they immediately backtracked and fell from those highs. All three grains closed modestly higher.
Obama's "Savior-Based Economy"
Mark Sanford, Governor of South Carolina, said recently in a CNN interview that we're moving close to a savior-based economy. This is only going to get uglier and uglier, until Americans wake up to realize that they've lost both their prosperity... and their freedom!
Tuesday, May 19, 2009
More Trouble for the Dollar
The Dollar hit a fresh low for 2009 today, breaking through support.
from Barrons:
CHINA ISN'T JUST TALKING ABOUT supplanting the dollar as the center of the international monetary system. It is taking concrete steps away from the greenback for both finance and trade.
The Financial Times reports China and Brazil have discussed using their own currencies for trade, a marked shift away from the use of dollars, the norm for the conduct of international trade.
There have been proposals over the years to use currencies other than the dollar for trade, most notably by the Organization of Petroleum Exporting Countries. OPEC has made noises about pricing its oil in a basket of currencies or perhaps the euro to offset the cartel's currency losses when the greenback would take one of its periodic headers.
But nothing ever has come of those threats. And even with the introduction of the euro as the first, real potential rival, world trade continues to be conducted overwhelmingly in dollars.
The global use of dollars has been an enormous advantage to the U.S., affording the nation the ability to spend and borrow nearly without limit. As long as the rest of the world wanted and needed dollars for trade in goods and financial transactions, America could effectively just reel off greenbacks to pay its bills.
"the new budget is a means to altering the very architecture of American life, with government playing a much larger role than before"
The headline above is a direct quote from the 2009 budget of the Obama Administration. What follows is from John Mauldin's Outside the Box and his introduction to it.
Nearly everyone I talk with has the sense that we are at some critical point in our economic and national paths, not just in the US but in the world. One path will lead us back to relative growth and another set of choices leads us down a path which will put a very real drag on economic growth and recovery. For most of us, there is very little we can do (besides vote and lobby) about the actual choices. What we can do is adjust our personal portfolios to be synchronized with the direction of the economy. The question is "What will that direction be?"
Today we are going to look at what I think is a very clear roadmap given to us by Dr. Woody Brock, the head of Strategic Economic Decisions and one of the smartest analysts I have come in contact with over the years. This week's Outside the Box is his recent essay, "The End Games Draws Nigh." For those who have the contacts in government, I urge you to put this piece into the correct hands so that Woody's very distinct message gets out. I think this is one of the most important Outside the Box letters I have sent out.
Woody normally does not allow his work to go beyond the circles of his clients, but I suggested to him that this piece was quite macro in cope and important for both individuals and policy makers everywhere to understand. In my own simple terms, trees cannot grow in some unlimited manner to the sky. Families cannot grow debt without limit beyond the growth of their incomes. And countries have the same constraints. While growth of debt in the short term is viable, growth of debt faster than the growth of GDP is not viable over the long run. This is not debatable. It is a simple fact. Therefore, as Woody says, it is important that you get the growth side of the equation right as you increase the debt side. Without the proper balance, you are heading for disaster.
From his intro:
"We weave these three concepts together so as to make possible an extension and generalization of "macroeconomic policy" as normally understood. Central to this extension is the need for policies that drive down the nation's Debt-to-GDP Ratio over time. Accordingly, we identify 15 policies that jointly reduce the growth of federal debt and increase the growth of GDP over time. Doing so not only points to a new set of policies for exiting today's quagmire, but also permits an appraisal of the Obama administration's current policy proposals. Regrettably these proposals do not fare well with respect to growth. Furthermore, the extension of macroeconomics we propose applies not only to the US economy, but to most all others as well. It should thus be of interest to readers everywhere."This is longer than the usual Outside the Box, and will require you to put on your thinking cap. But you need to digest this, and especially the conclusions. But it is very important that you understand the principles and concepts Woody discusses. We are at a very critical juncture, and the paths we choose will have profound impacts on our lives and fortunes. I cannot overemphasize the point. If we choose a path of growing debt faster than we can grow GDP, the negative implications for many traditional asset classes are enormous.
Let me again thank Woody for allowing me to send this on to you. And for those who post this letter on various sites, just be sure to include a link to Woody's website, www.sedinc.com. For those interested in his subscription service you can contact Woody at woody@sedinc.com or visit his website.
Thanks,
John Mauldin, Editor
Outside the Box
The End Game Draws Nigh – The Future Evolution of the Debt-to-GDP Ratio
By Horace "Woody" Brock, Ph.D.Preface: In this new report, we link together three quite different concepts that have been discussed in these publications during recent years. First, the problems posed for classical fiscal and monetary policy when extremely large deficits must be financed; second, the critical importance of the rate of economic growth as primus inter pares of all economic variables; and third, the all-important concept of "incentive-structure-compatibility" introduced by Leonid Hurwicz in the 1960s, and recognized in the award to him in 2007 of the Nobel Memorial Prize.
We weave these three concepts together so as to make possible an extension and generalization of "macroeconomic policy" as normally understood. Central to this extension is the need for policies that drive down the nation's Debt-to-GDP Ratio over time. Accordingly, we identify 15 policies that jointly reduce the growth of federal debt and increase the growth of GDP over time.
Doing so not only points to a new set of policies for exiting today's quagmire, but also permits an appraisal of the Obama administration's current policy proposals. Regrettably these proposals do not fare well. Furthermore, the extension of macroeconomics we propose applies not only to the US economy, but to most all others as well. It should thus be of interest to readers everywhere.
A. Introduction and Overview
In our 2008 research programme, we focused on three issues. First, what exactly caused the worst credit crunch the nation has arguably experienced since the depression of the 1930s? Second, how did the downturn in the US morph into a collapse in Planet Earth's GDP rate from nearly 5% in June 2008 to -0.5% in winter 2009? Third, can traditional macroeconomic policy suffice to turn around the economy? More specifically, will a killer application of classical fiscal and monetary policy truly restore the economy to a stable growth trajectory? Or is there an internal contradiction within macroeconomic policy that could prevent it from succeeding this time around?To explain the "perfect storm" in the credit market, we drew extensively on the new Stanford theory of endogenous risk to demonstrate that there are three jointly necessary and sufficient conditions to predict and explain the perfect storm we have experienced: (i) A mistaken market forecast of some exogenous event that impacts security prices (in this case, a vastly higher than expected default rate on mortgages); (ii) A high level of Pricing Model Uncertainty bedeviling bank assets (the true cause of the "toxicity" of those complex securities that have clogged the
arteries of the banking sector); and (iii) An unprecedentedly high degree of leverage in the financial sector (money center banks had off-and-on balance sheet leverage of about 40:1 in contrast to the socially optimal leverage of 10:1). The reader can tack "greed" and "incompetence" onto this triad, although doing so diverts attention from the real causes of today's crisis.
To explain the collapse of economic growth worldwide in an astonishingly short period, we utilized a game theory model that explained how the cessation of inter-bank lending amongst the principal money center banks of the world precipitated the first known case of global credit market emphysema: The availability of credit dried up almost everywhere in the course of six months, from Auckland to Iceland. We stressed that this credit contraction had little to do with "globalization" as properly understood, and had no counter-part in history.
To explain the potential failure of fiscal and monetary policy in restoring growth, we demonstrated how the financing of exceptionally large government deficits usually causes a sharp rise in longer-term real interest rates—a rise that bites back and offsets the GDP impact of the fiscal stimulus being applied. The logic leading to this conclusion is reviewed just below in the context of Figure 2.
B. The Good News — A World of Greatly Reduced Uncertainty
A year ago, even six months ago, the great debate centered on whether the credit market crisis would precipitate either a US or global recession. A majority predicted a manageable recession in the US, but nowhere else with the possible exception of the UK. Uncertainty was great, and kept increasing until recently—but no longer. The good news today is that this uncertainty has disappeared. For we now know with probability 1 that everything sucks everywhere. Welcome to a risk free world!To wit, the G-7 economies are all in recession, and more astonishingly the economy of the planet earth is growing at about -1% or even less. Earnings are crumbling, global trade has decreased by nearly 10%, rising global unemployment foretokens social unrest in many quarters, industrial production has dropped more than ever before, and excess capacity is rising in almost all manufacturing sectors globally. Stephen Roach of Morgan Stanley believes that the "world output gap" could reach a mind boggling 8%–10% by year end. All in all, we have witnessed problems that originated within the US give rise to global scenarios that were virtually unthinkable as recently as the summer of 2008, and do so with blinding speed.
Within the US, there are two parallel problems. First, the nation faces a hitherto unprecedented growth of Federal debt, over both the short and long run. Second, there is the severity of the recession itself. Figure 1 offers a simple way of understanding what killed growth in the US economy. The variables shown remind us of the old adage that "History rhymes, but does not repeat."
History Rhymes: More specifically, the contents of the figure will disturb those seeking to identify today's US recession with earlier ones in 2001 or 1991 or 1981 or 1973 or even 1931. No such identification is possible since the three developments highlighted in the chart and their improbable synergies are different from anything we have seen before. This sui generic nature of today's crisis explains why traditional theories of recessions and "debt super-cycles" possess little explanatory and predictive power.
For example, according to standard business cycle theory, "pent-up demand" on the part of consumers is a principal driver of recovery—but it will not be this time around. The shift towards less consumption and more savings due to the implosion of household balance sheets and to demographics is most probably permanent. If so, this bodes poorly for hopes of a pent-updemand-driven recovery.
History Repeats: While the context of today's crisis differs from those in the past, history repeats itself in that the common denominator of this and all other debt crises has been excess leverage—our mantra in these pages for three years. Our greatest fear was that the all-important role of leverage would be sidestepped in the rush to assign blame and reform the financial system. In this regard, it is dismaying that, whereas we have now vented our anger at bankers and capped bonuses, we have not capped leverage. To be sure, there are calls for "improved bank capitalization" and related reforms, but the crucial role of excess leverage in bringing down the global financial system has not been properly recognized. Instead, excess "greed" has been the principal focus.
Then again, from a game theoretic viewpoint, it may not be surprising that the role of leverage has been underplayed. For leverage is precisely what is required for financiers to reap those huge incomes needed to fund both political parties in Washington, not to mention those "blockbuster" exhibitions we all love so much at the Metropolitan Museum of Art in New York. Stay tuned for Loophole Analysis 101.
C. The Bad News — Two New Uncertainties
Two new uncertainties are now rising to the fore. First, will traditional fiscal and monetary policy suffice to restore economic growth—and in the process restore the viability of the financial sector? Without the latter, there is little hope of revived growth. Our concerns about the inadequacy of traditional macroeconomic policy were discussed at length in our February 2009 PROFILE, and are summarized in Figure 2 taken from that analysis. The flattening out of the stimulus curve in the figure reflects that, when fiscal stimulus exceeds a certain level (e.g., 7% on the horizontal axis), the financing of deficits is likely to cause a sharp increase in real longer-term interest rates. Importantly, this holds true regardless of whether the huge deficits are monetized for reasons we carefully articulated. Higher real yields in turn neutralize the original fiscal stimulus, thus causing the curve to flatten out.1We concluded that the risks of policy failure in today's context are disturbing. Moreover, even if traditional policies do prove successful in the shorter run, there is a genuine risk that the huge amount of debt that accrues and must be serviced in the future could transform the US into a "banana republic" in the much longer run. This risk is heightened by the need to fund soaring Social Security and Medicare "entitlements," as record numbers of baby-boomers retire during the next two decades. Moreover, as time goes on, it is precisely these longer-term risks that will matter most to the market, and will increasingly be discounted. Investors of every stripe will be impacted.
The second new uncertainty focuses on whether new and different fiscal and monetary policies can help salvage matters, and guarantee a happier ending.
If the effectiveness of traditional macroeconomic remedies is in doubt, can its arsenal of policies be expanded so as to restore strong longer-term equilibrium growth? The answer is yes, and it is the purpose of this new essay to sketch such an extension of classical macroeconomics.
D. The Critical Dynamics of the Debt-to-GDP Ratio
There is nothing new about a nation running into trouble and running up large amounts of debt in bailing itself out. There is also nothing new about attempting to monetize (via "quantitative easing") the resulting accumulation of debt. The good news for the US is that its total federal debt of some $10T at the outset of the crisis in 2008 was a manageable 70% of current GDP of $14T.2 Suppose debt rises $3T by the end of 2011 as the Congressional Budget Office now predicts, and then rises $7T more by 2020. The result will have been a doubling of federal debt between 2008 and 2020, rising from $10T to $20T.3 While this increase is shocking, some forecasts are much worse.Suppose, moreover, that GDP rises conservatively to $17 trillion in 2020 from today's $14T as a result of a modest 2% GDP growth recovery between 2011 and 2020. Then the federal Debt-to-GDP ratio would rise from today's 0.7 to 1.18. Interestingly, this does not represent the disaster many observers assume. To begin with, there are nations where a disturbingly high Debt-to-GDP ratio proceeded to fall way back down over time. Thus, the US Debt-to-GDP ratio was 1.25 at the end of World War II, yet it fell to 0.25 by 1980. Britain's Debt ratio upon defeating Napoleon in 1815 was over 2.7, and it fell back to 0.2 by the end of the 19th century.
In other cases, the Debt-to-GDP ratio has stayed persistently high, neither increasing nor decreasing dramatically over time. Thus Japan has had a very high ratio of 1.5 to 1.8 for the past decade. Italy and Belgium, too, have sustained high ratios in the range of 1 to 1.25. Finally, there are the countries where the Debt ratio continues to rise after some initial shock with either hyperinflation or outright default being the end result. Such has been the fate of myriad banana republics including some large players such as Brazil, Argentina and Russia. What exactly determines which nations dig their way out, or else go under? This will be our primary focus in the pages ahead.
Rebounders versus "Banana Republics": To begin with, note that what matters is not a onetime rise in the Debt-to-GDP ratio due to a particular shock (e.g., today's US housing and credit crises), but rather the dynamic trajectory of the ratio in the years subsequent to the initial rise. It is the direction of this trajectory that is all-important. If the Debt ratio continues to rise, then it tends to accelerate due to the ever-rising cost of servicing this ever-rising "primary" deficit. Not only does the increasing debt-load itself cause ever-higher servicing costs, but the rising real rates that typically result from ever-greater debt make the spiral ever worse. The result can be economic and social collapse.
If, on the other hand, the Debt-to-GDP ratio stagnates, it tends to be associated with very low real growth, political paralysis, and a degree of social disenchantment. If the ratio falls, it is usually because of a combination of two developments: higher real growth and vigorous fiscal discipline. Rising living standards, dreams of a better future, and a sustained belief in democracy are associated with this happiest of trajectories.
Three Sets of Scenarios: Figures 3.A – 3.C illustrate the stunning range of outcomes that can result from sustained differences in the growth rates of debt versus of GDP. We have adapted the analysis here to the case of the US. We assume an initial federal debt burden of $12T for 2011, and an initial GDP value of $14T. We then grow these forward at the stipulated growth rates.
At the one extreme of very low economic growth and very high debt growth, the Debt ratio rises to an arresting 18—a half-way house to Zimbabwe. At the opposite extreme, the ratio falls to a paltry 0.4, half of today's level. These two extreme outcomes are circled in the table.The data in the tables represent real growth rates of both debt and GDP.
E. The Case for Driving Down the Debt-to-GDP Ratio – "It's the Growth Rate, Stupid!"
We can deduce from the foregoing analysis that sustainable long run economic recovery from a debt overload requires two sets of policies: One set must be dedicated to curtailing the growth of government spending and hence, the growth of the deficit. The other set must be dedicated to maximizing real economic growth. In this way, both the numerator and the denominator of the killer Debt-to-GDP ratio will be managed so as to maximize future social welfare.Policies aimed at augmenting real growth are arguably the more important here. This is because more rapid growth not only reduces the Debt ratio, but also causes swelling tax revenues which can help to reduce the deficit each year. That is, stronger growth drives both the numerator and the denominator in the right directions.The True Payoffs from Strong Growth: Looking at matters from a game theoretical "Who wins?" standpoint, strong economic growth is the rising tide that lifts all ships. Within a given nation, it alone offers win-win strategies whereby most all interest groups can come out ahead. Externally across nations, strong growth generates expanding trade. Happily, the game of trade between nations is that all-important positive-sum game that encourages peace and discourages war. It creates "the ties that bind." For example, the recent globalization of the supply chain is a principal reason why the business community has been so strangely silent in demanding protectionist policies during the present crisis. When a significant portion of your own manufacturing inputs come from "abroad," do you really want trade barriers?
This reality underscores why "It's the real growth rate" must become the mantra of recoveries not only in the US, but almost everywhere else as well. Note that this "strong growth" mantra is a far cry from the Obama administration's counsel to the world at the recent G-7 conference: "Stimulate everywhere by running higher deficits!"
Finally, and perhaps most importantly, productivity-driven strong growth alone increases living standards that boost the hopes and dreams of people everywhere for a better tomorrow for their children. When citizens have realistic hopes of a better tomorrow, social unrest is minimized. Conversely, when prospects for the long run are grim, voters are easily swayed by demagogues to vote for the Hitler of their day.
Three Important Books: Are these points obvious? They should be, but they frankly are not. Moreover, they are never sufficiently emphasized, and virtually no orientation towards rapid future growth is evident in the policies and "reforms" proposed by the Obama administration, as we see in Section G below. The arguments set forth in three books support the view we are taking as regards the critical role of growth.
First, a widespread lack of understanding and appreciation of growth led Professor Ben Friedman of Harvard University to write his superb book, The Moral Consequences of Economic Growth (A. Knopf, 2005). This is the best work we know of that makes the case for growth and (more implicitly) for globalization at an appropriate economic and moral level of analysis.
Second, and at a more practical level, Alan Beattie's brand new book False Economy: A Surprising Economic History of the World (Riverhead Press, 2009) provides myriad case studies of how nations chose between success or survival or ruin by the specific policies they adopt. His case studies make very clear indeed how policies that depress the Debt-to-GDP ratio of Figure 3 correlate strongly with success, whereas policies that inflate the ratio correlate with ruin.
Third, at an even deeper and more theoretical level, there is the late Mancur Olson's magisterial The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities (Yale University Press, 1982). Olson explains from first principles how special interest groups become entrenched and, in defending their turf, usually cause nations to go bust. [Our "entitlements lobby" anybody?]
Olson's logic is game theoretical: He shows that special interest groups become the principal players in a generalized Prisoner's Dilemma game whereby individually group-rational strategies lead to the collectively irrational outcomes of declining growth, diminishing dreams, increasing social unrest, and ultimately ruin.This book should be required reading by anyone serving in government. It is one of the best books the present author has ever read in the field of political economy.
F. Four Debt-Minimizing Strategies
Before turning to those all-important strategies for maximizing the growth in the denominator of the Debt-to-GDP ratio, consider several different strategies for minimizing the growth of the numerator.First, counter-cyclical policies should consist of temporary increases in spending—spending that automatically expires with no Congressional vote when good times return. The Obama administration policies largely amount to permanent spending increases, and have been widely criticized as such.
Second, a new set of government accounts must be introduced that clearly distinguish government investment expenditures from non-investment expenditures. The former should not be included as part of "the deficit." Only an appropriately amortized portion should be included. Moreover, for reasons stressed below, infrastructure investments should take priority when discretionary government spending decisions are made. The current administration has not proposed the required accounting changes. This is, of course, consistent with its failure to propose serious investment spending in the first place (see below).
Third, true leadership—not to be confused with fine rhetoric—is needed to alert citizens to the true disaster we face if the growth of long-term federal debt is not curtailed. This is particularly true given the demographic realities that now lie around the corner. Nobody has made this point better than Stephen Roach in a recent commentary in Morgan Stanley's "Debating the Future of Capitalism" series, March 26, 2009:
I believe that Congress and the White House should collectively declare a formal "fiscal emergency" and empower a bi-partisan task force to develop new guidelines for federal budgetary control.Slam Dunk! Given the reality that today's deficit crisis far exceeds that of the Reagan era, it is all the more irresponsible that the President has not already proposed the "fiscal emergency task force" that Roach correctly calls for. Paul Volcker: Where are you when we need you the most? The reforms that such a task force would propose are all pretty obvious, including "sunset provisions" for all manner of government mandates, entitlement reforms, an end of ear-marking, etc.
Washington did this once before in an effort to contain the runaway budget deficits of the Reagan era—deficits that now look like child's play when compared with what lies ahead. The automatic spending caps and sequestration mechanisms prescribed by the GrammRudman-Hollings Balanced Budget and Emergency Deficit Control Acts of 1985 succeeded in taking some of the optionality out of the fiscal debate.
This problem is too big—and the long-term stakes are too high—for fiscal sustainability to be entrusted to the oft-politicized whims of the year-by-year discretionary budgeting process.
Fourth, as noted in Section E above, policies must be adopted that maximize economic growth since faster growth is the best way to generate those higher revenues needed to reduce a given deficit. We identify specific growth policies just below.
Lingering Doubts: Even longstanding Democratic Party liberals are now expressing shock at the staggering growth of long-term government debt the US now confronts. Nonetheless, the President's cheerful rhetoric suggests little concern with the growth of the numerator. To be sure, his administration's OMB budget projections blithely assume that very high growth rates will magically return after the next three years, and nothing solves fiscal problems as well as rapid growth. Yet everyone acknowledges that these projections are smoke-and-mirrors, constituting a leadership default of the first magnitude.
Yet could all of this be deliberate? Could the administration's choice to tax and spend ad infinitum have been politically strategic in nature? After all, haven't both President Obama and his chief of staff Rahm Emanuel openly admitted that "the new budget is a means to altering the very architecture of American life, with government playing a much larger role than before"? The likelihood that their new architecture would drive the growth of numerator of the Debt-to-GDP ratio ever-higher and the growth of the denominator lower was never mentioned.
Do financial commentators even understand this risk? While the press has expressed appropriate "concern" about the sea of red ink to come, there is little sense of the true End Game at stake: Which of our Figure 3 scenarios will occur, and what will it imply?
The answer may well determine whether we face a future of peace and prosperity, or of war and privation. As a personal aside, this author has never been more concerned than he is now about the economic state of the nation.
G. Growth-Maximizing Strategies
We now identify a plethora of growth-maximizing policies. Before doing so, however, we must recall the true origins of economic growth itself. Only by understanding these origins can we identify meaningful pro-growth policies.G. 1. The Two Principal Sources of Real Economic Growth
At the most basic level, trend growth is the sum of workforce growth plus productivity growth. Intuitively, this rate of growth equals the rate of growth of the number of workers producing the pie, plus the rate of increase of pie production per person hour. In the latter case, we distinguish between productivity increases that result solely from "working smarter" versus increases that result from increased investment per worker, or "factor stuffing" in economics jargon. The former is called pure labor productivity growth (e.g., take a weekend off and invent the differential calculus), whereas the latter is referred to as total factor productivity growth.The very rapid growth of emerging economies is usually due to a very high rate of increase in total factor productivity growth as workers gain access to roads, computers, medicines, and other productivity-improving (but not free!) endowments for the first time. Developed economies cannot replicate this strategy, so their growth rate is much lower than the "catch-up" rates in newer economies.
Thus, policies that augment growth must operate through two channels: Increasing productivity growth (via enhanced skills and investment), and/or increasing workforce growth.
Incentive-Structure-Compatibility: In proposing pro-growth policies of both kinds, we shall keep in mind the requirement that such policies be "incentive-structure-compatible" with growth, a concept first articulated by the economist and philosopher Leonid Hurwicz in the late 1950s. Everyone acknowledges the importance of incentives in a given situation, e.g., the appropriate carrots and sticks needed to raise children, to motivate workers, etc.
What Hurwicz first articulated was the way in which the totality of incentives throughout society—its "incentive structure"—could be conducive to achieving a particular societal goal, such as maximal growth. The great importance of Hurwicz's concept is that it provides the correct analytical bridge between the micro and macro domains of social life. This was a stunning achievement, and earned him the 2007 Nobel Memorial Prize.4Most "policies" and "goals" promulgated by politicians turn out not to be incentivestructure-compatible with growth, or with any other defensible objective. That is to say, most policy proposals are hot air.
Figure 3 summarizes the structure of our argument up to this point.
G.2. Productivity-Enhancing Growth Strategies
During the past three decades, a great deal of research has been done to understand the true sources of productivity growth. In particular, Paul Romer of Stanford University developed his theory of "endogenous growth" in which the rate of productivity growth is determined within the economic system, as opposed to being modeled as an external "residual" as it previously had been. In what follows, we draw on this and related research in an informal manner.1. Infrastructure-Orientated Fiscal Stimulus: Economists increasingly believe that consumption will fall by 7% from its 72% share of US GDP in 2007 to around 65% over the next three years. Moreover, they believe it will remain at a significantly lower level. Pessimists conclude that "without a recovery of household spending to previous levels, the economy will suffer for a long time." Yet this is not the case.
Should investment spending (both in the corporate sector and in government infrastructure spending) rise by an offsetting 7% of GDP, the growth rate of GDP will not only match, but in fact exceed its old rate of growth. This is due to the role of classical macroeconomic "accelerator/multiplier" theory: A dollar invested will generate much greater future output than a dollar of transfer payments or consumption-stimulating tax cuts.
As regards today's humongous fiscal deficits, this reality implies that, the more the deficit is dedicated to infrastructure investment each year, then (i) the greater productivity will be (recall that investment raises productivity), and (ii) the greater both job growth and output will be over time via the Keynesian multiplier theory. Since virtually everyone recognizes that US infrastructure spending has been woefully inadequate for decades, and that consumption has been excessive, the current recession has, in fact, presented the government with a golden opportunity to "rebalance" the composition of GDP in a highly desirable manner.Yet there are two additional reasons why the increased deficit should be infrastructure-investment-orientated. First, government expenditure on productivity-raising investment is not, in fact, "an expenditure" that raises the deficit and frightens bond market vigilantes. For as explained above, government investment spending of this ilk should be amortized over time. Thus, the larger the investment share of a given stimulus package, the smaller the resulting deficit. Second, to the extent that today's deficit explosion burdens the young with much more debt to be serviced, then it is our moral obligation to dedicate the extra spending to investments that raise the productivity growth and thus the size the future GDP. Doing so clearly reduces the real burden on future tax payers of servicing the debt being accumulated today.
Given this rare opportunity—and moral obligation—to tilt the economy towards long overdue investment spending, how can the Obama stimulus package have fallen so short of the mark? It is frankly embarrassing to witness Chinese policy advisors like Professor Yu Qiao of Tsinghua University scolding the US about something as basic as this:
Most of Mr. Obama's stimulus spending is devoted to social programmes rather than growth promotion, which may exacerbate America's over-consumption problem and delay sustainable recovery.Qiao's point parallels a principal point we are making in this essay. Why are we not reading this from Christina Romer or Larry Summers in Washington? Have the Best and the Brightest once again lost their moral integrity as they did during the Vietnam War era? Can they seriously believe that more transfer payments to Democratic Party special interest groups is what the nation needs in this hour of its distress? The author considers the composition of the proposed $3 trillion of discretionary stimulus over the next five years a moral travesty.
Financial Times, Editorial page, April 1, 2009
Case Study of Energy: As a case study in how poor the administration's policies are in this regard, consider its energy policies. Is anyone in the new administration reading about the disastrous 9% annual decrease in the output of "old" oil (yes, "peak oil" turned out to be true), in conjunction with a collapse of previously scheduled investments in exploration and development, and in refining capacity? Are they blind to the supply-crisis that is unfolding, one that calls not only for "renewable energy," but also for a major expansion of traditional oil and gas production?
By now, has it not become crystal clear that the increased production of traditional fuels should come from within the US, given the devolution of both the political leadership and the infrastructure of those thugocracies upon whom the US increasingly depends for 40% of its consumption? Is no thought being given to the rising probability of $500 oil prices—or perhaps outright rationing—when global energy demand recovers? [Recall how jointly price-inelastic demand and supply curves cause huge changes in price both upward and downward, as we demonstrated mathematically five years ago.]
Elementary arithmetic is all that is needed to ascertain that the administration's BTU gains from increased renewable energy production and conservation from increased "weather-stripping" will not yield even 10% of the BTU shortfall that the nation will confront. The reality, therefore, is that the country needs a vast expenditure of funds on novel and traditional sources of energy, as well as on our deteriorating energy infrastructure. Expenditures of this kind would create several million jobs of precisely the kind that are needed during the next decade. And they would leave the next generation with an improved infrastructure, in addition to lessening our extraordinary dependence on imports from rogue states.
But what do we get from the Obama team? A present value tax hike of up to $400 billion on "big oil" in one form or another, along with weather-stripping tax credits and expenditures on renewable energy alone. And who is the newly appointed spokesman for national energy policy? A highly credentialed academic who strikes virtually everyone as indecisive and ineffectual. Does even one reader of this essay know his name? [Steven Chu] Of course, his Nobel Prize supposedly substitutes for his lack of political skills. By extension, are we about to witness the "quant" financial theorist Myron Scholes appointed as Treasury Secretary after Tim Geithner steps down? After all, Scholes too, is a Nobel laureate, even if his notorious "pricing models" helped to bring down Long Term Capital Management and then the world economy a decade later. The Lord save us from "The best and the brightest!"
2. Stimulation of Innovation and Venture Capital: While increased infrastructure investment is one channel to higher productivity growth (and hence higher GDP growth), innovation is another. As someone who lived in Menlo Park, California for two decades between 1980 and 2000, the author was privileged to witness first hand the stunning comeback of the US from its "rust bowl" status of the 1970s.
The comeback was almost entirely due to a broad array of venture capital sponsored innovations, starting with the micro-processor. In a Memo he wrote for Mssrs. Clinton and Rubin in 1996, the author demonstrated that the US had an "Innovation Quotient" 17 times higher than that of our next competitor. [Finland. Think Nokia!] As a result, US productivity growth doubled from its depressed level of 1.4% in the 1970s to 3% by the late 1990s and early 2000s. No other nation came close to this achievement.
Yet now, when we need renewed innovation and enhanced productivity growth as much as we did in the 1970s, we read that the Obama Treasury Secretary Geithner has proposed to regulate the venture capital industry. Specifically, he has called for mandatory SEC registration of large firms, lest the sector become a "systemic risk" like hedge funds and proprietary trading desks. As Jack Biddle of the VC firm Novak Biddle Venture Partners has pointed out in a Wall Street Journal interview (April 9, 2009):
I cannot imagine any venture capital firm being of a size to pose 'systemic risk,' so they (the administration) either do not understand the nature of the business, or...What Washington needs to understand is that bank-style regulation could destroy the culture that created the micro-processor.3. Education and Elitism: In contemplating the sources of productivity growth, we would all do well to recall Isaac Newton's celebrated confession that, in developing his theory of mechanics and the differential calculus, "I stood on the shoulders of giants." Politically incorrect as it is to admit, we need policies that identify and reward elite young people and entrepreneurs from a very early age, and do so regardless of where they come from. Indeed, we should be seeking young scientific talent worldwide and paying for immigrants to come to the US and study.
Instead, the stimulus package dedicates significant funds to lowest common denominator educational expenditures. In particular, virtually nothing is being proposed to end the monopoly of teachers' unions that discourages qualified teachers from attempting to teach. The consequences for productivity growth of the longstanding decline of our public schools is by now well known, and has been articulated by public figures ranging from Bill Clinton to Bill Gates and Steve Jobs.
4. Taxation that Rewards Innovation and Success: Both the president and his chief of staff Rahm Emanuel have been completely candid about their redistributionist agenda—an agenda that has even alarmed European liberals. Were they at all concerned with innovation, productivity, and growth, the administration would not publicly espouse taxation policies that punish success and reward failure. In particular, they would not have declared war on small business, since small businesses typically generate the bulk of new jobs and innovations that determine the rate of economic growth.
To be sure, disparities in the current tax code do permit Warren Buffet to incur a much lower tax rate than his receptionist, as he quipped. Such inequities must be remedied. But the fact remains that the top decile and quartile of income earners in the US pay a larger share of government tax revenues than in any other G-7 nation. If so, why does the president assume it is "fair" to hike the tax rates on top income earners, and only on this group? From an employment standpoint, the new tax rates may well send talented young Americans to live elsewhere. Starting in 2011, a New York City wage earner will pay a marginal tax rate (federal, state, and local) of over 60% on "high" incomes of $200,000. This rate is higher than comparable rates in Germany and France where taxes paid secure decent schooling and medical care, which they do not in the US. Yet even so, France has witnessed a veritable diaspora of young talent to London, the US, and Switzerland during the past two decades.
5. Incentives for Investment in the Private Sector: Productivity growth comes not only from government-sponsored infrastructure of the kind discussed above, but also from investment by private businesses of all sizes in new capital stock. It is not clear what the new tax policy will be towards investment tax credits, but such credits have not yet been identified as important. They are important, especially at a time when the search for higher productivity and hence higher economic growth must become the nation's number one priority.
6. Less Regulation, Not More: "Re-regulation" is back in vogue. But increased regulation where it's not needed chokes off innovation and growth. While the financial sector clearly needs re-regulation, it is not clear that other sectors do. Should the new administration become growth-oriented, then it must be very careful not to choke off the all-important forces of "creative destruction."
Even in the financial sector, overkill is likely. In our own view, two general forms of regulation are needed. First, incentives must be properly aligned (e.g., banks issuing securitized products must hold a certain proportion of such products in-house.) Second, leverage must be radically curtailed, a point we have stressed for three years. As for "excess pay," the limitation of leverage and proper alignment of incentives will automatically remedy most excesses of recent years. In brief, the less regulation the better.
G.3. Workforce-Enhancing Growth Strategies
1. Strong GDP Growth: The six growth-maximizing strategies above will do more to boost workforce growth than anything else. The strong correlation of workforce growth and GDP growth is well understood at both an empirical and theoretical level. Most important, perhaps, is the need to stimulate innovation so that new industries can rise and replace old industries via the unfettered forces of creative destruction. Indeed, new industries have contributed over 75% of job growth in the US during recent decades. Numerous studies have shown how policies preventing creative destruction within most of Europe depressed private sector job creation during recent decades. Most job creation occurred in the public sector. Regrettably, none of these employment realities have been discussed by the new administration.2. Deficit Composition: Utilization of today's huge deficits for boosting investment expenditures triggers those accelerator/multiplier effects cited above that boost employment far more than transfer payments or tax cuts do. Yet the administration's stimulus package is very infrastructure-lite, as was discussed above.
3. Deregulation of the Labor Market: Labor unions have long wanted to return to the practices of card-check balloting (or majority sign-up) without secret balloting. Yet such practices are definitionally anticompetitive, and retard employment growth. The administration initially supported card-check legislation or the so-called Employee Free Choice Act, but does not have enough votes to impose it. As to the tricky issue of immigration, the Obama team is doing a good job to date supporting rights for undocumented workers who have played such an important role in the nation's economic history, and must continue to do so in the future.
4. Managing Demographic Change within the Labor Market: There will be new and important tensions within the US labor market, given the likely influx of millions of post-65 year old boomers. It is becoming clear that the retirement planning of this generation was woeful, with up to half of boomers expecting they could afford a retirement financed by the ever-rising values of stocks and houses. Such expectations have been shattered, and many boomers will have to work until age 75 to afford the lives they expect.
In many ways, this is a good development. However, it presupposes that the requisite jobs exist. Yet they will not exist unless labor markets are deregulated, not re-regulated. In particular, minimum wages and guaranteed hours of work must go by the boards. Maximum flexibility will be needed to equate supply and demand in the labor market, thereby reducing tensions between older and younger job-seekers. Such tensions have already begun to appear in today's scramble for jobs.
A welcome dividend of elderly workers joining the workforce will be the reduction of the Social Security Trust Fund deficit. If the average retirement age de facto (not de jure) rises from 64 to 70, trillions of dollars of unfunded liabilities will evaporate as people draw upon their Social Security entitlements later, and contribute longer. The present value of the resulting fiscal savings is truly huge, making it all the more important that the US labor market become as flexible and efficient as possible. The administration has never touched upon this issue.
5. Tax Policy: Any student of public finance will recall that the best kind of tax is the tax that least distorts the efficiency of the economy. The Value Added Tax (VAT) is well known to be optimal in this regard. Conversely, taxes on labor (e.g., income taxes) distort workforce growth and thus, economic efficiency the most. But the administration is wedded to higher taxes on labor, and has never proposed a VAT.
This concludes our identification of over a dozen policies that can drive the Debt-to GDP ratio down. Please note that each of the pro-growth strategies is incentive-structure-compatible with growth, as desired and as promised up front.
H. Conclusion: When Being "Smart" Is Not Enough
This essay began with a demonstration of the all-important role of the evolution of a nation's Debt-to-GDP ratio. The direction of this evolution is a good proxy for the future success or failure of the nation. We argued that a one-time shock (like today's US recession) that drives the initial Debt ratio way up does not pose the problem most people assume. Long run recovery is possible, but only if policies are adopted that drive the growth rate of the numerator down, that of the denominator up, and thus that of the ratio down.We then identified over a dozen policies that can achieve the goal of driving down the Debt-to-GDP ratio in the longer term. The End Game that is now being played is whether policies of this kind are adopted, or whether they are not. In our view, the Obama administration has adopted both a philosophical perspective and a set of policies that will drive the ratio up. If this is indeed the price of a "new American social architecture," then it is a price that is too high.
We also proposed that these "ratio management policies" should be viewed as a refinement, and indeed an extension of classical monetary and fiscal policy. They add a new dimension to the concept of "macroeconomic policy," and to its objectives.
Why do so few administration spokesmen or economic commentators seem to share our views? Is "politics" the problem? We do not think so, at least to the extent that growth-maximizing policies are win-win policies that any good politician should be able to sell. No, the problem is rather one of the mind-set of a generation that has never before needed to confront the problems lying ahead, and that is tone deaf to philosophical issues, as opposed to "policy wonk" issues.
Today's True Challenge — Governance: In this vein, we proposed at the end of our February 2009 PROFILE that the root problems of today are not macroeconomic as much as they are political philosophical: How can democracy save itself from itself? How can people be made to realize that a reform of governance is what is now most needed—more so even than a reform of Wall Street? And even in the financial sector, it is increasingly clear that regulatory lapses in Washington were more responsible than "greed" for what has happened. Messrs. Rubin, Summers, and Greenspan actively encouraged the most pernicious of the deregulatory policies that brought down the system.
By now, it is clear that we need bold new constitutional amendments that mandate (i) sterilization of excess money creation during cyclical recoveries, (ii) fiscal surpluses during recoveries to pay down past fiscal deficits, and (iii) deficits during recessions tilted towards growth-enhancing infrastructure spending, not towards goodies for special interest groups.
In this regard, economists Martin Wolf and Stephen Roach have both correctly identified financial market "credibility" as the key to future growth, inflation, and interest rates. Can today's administration end up with any credibility when it blithely ignores the very existence of the End Game we have identified, much less those policies needed to solve it correctly? Will there be any credibility if the three proposed amendments just cited are not adopted?
In his magisterial The Rise and Decline of Nations, Mancur Olson understands that these are the topics that matter—not greed management 101. Yet barely a word is being said about these issues by the Best and the Brightest now staffing the Obama White House. Why? The explanation partly lies in a crisis of intellectual competence. Scholars trained in "macroeconomics" are as poor in discussing Olson's dilemmas of collective action as oncologists are in discussing dentistry. The fact that the macroeconomists in question are "brilliant" is irrelevant. Being smart is not enough.
The abject moral failure of the new team to identify much less to propose a solution to the End Game is extremely disturbing to the present author. Despite his initial support of President Obama, he increasingly wonders whether we have the right team in place. And he is alarmed that time to rebuild credibility is running out.
Subscribe to:
Posts (Atom)
