Wednesday, December 31, 2008
Among other things, the secretary is quoted as saying:
• “… we’ve done all this [in response to the financial meltdown] without all of the authorities that a major nation like the US needs.”
• “We’re dealing with something that is really historic and we haven’t had a playbook. The reason it has been difficult is first of all, these excesses have been building up for many, many years. Secondly, we had a hopelessly outdated global architecture and regulatory authorities …in the US.”
• Future efforts should aim at “better and more effective regulation.”
• “I am sure I am going to look back … and think of all kinds of things I wish I had done differently.”
On a personal level, I feel deep sympathy for the secretary and many of his colleagues who have had to preside over the dismantling of a system that earned them great wealth and sterling reputations. That must be painful and more than a little confusing.
However, I would like to ask Mr. Paulson whether every one of the statements made above might not apply equally to his failed policy to contain mercantilist currency policies. Haven’t the resulting imbalances – trillions of excess currency reserves and other assets in the hands of mercantilist governments – been building for years? Haven’t we lacked the “authorities,” i.e. an effective IMF and WTO as well as national policy tools, to deal with the problem? Don’t we need “better and more effective regulation” to manage the problem?
Paulson’s insistence that he had the tools needed to end monetary misalignment stands in stark contrast to his lamentations regarding financial fraud and failure. He’s wrong on the former for the same reasons as he’s right on the latter. The new administration should scrap this part of Paulson’s playbook and take a fresh approach.
Monday, December 29, 2008
In dealing with the eocnomic crisis, the new administration is not likely to have the same freedom. It’s got to get its own set of three R’s – relief, recovery, and restructuring – right and right from the start. Larry Summers’ op ed piece in yesterday’s Washington Post (“Obama’s Down Payment”) suggested a promising direction. The incoming economic point man touted Obama’s program in the works, the “American Recovery and Reinvestment Plan,” as a way of supporting the “jobs and incomes essential for recovery while also making a down-payment on our nation’s long-term financial health.”
For me, relief is a matter of putting cash and credit in the hands of the many millions of individuals and businesses who desperately need it to avoid calamity. Other sources indicate that the new administration might be considering some form of broad-based immediate tax relief as a way of reinflating disposable income. While they’re at it, the Obamistas might consider relieving employers of FICA payments for the first six months of 2009 to ease labor cost pressures and business cash flow crunches.
Recovery is more a matter of recovery sustained over time with a generous dollop of confidence building. Smart regulation will help in that regard, as we try to convince American creditors with money and those without enough to trust one another again. In his op ed, Summers revised the Obama jobs target again: now it’s 2.4 million private sector jobs and 600,000 government positions. However, as I previously commented, even three million private sector jobs over the next two years wouldn’t come close to qualifying as a real recovery.
Restructuring is what interests me most. That’s partly a matter of investment, of course. Summers makes a good pitch for considering spending on infrastructure, health care, and education as “investments that will work for the American public.” The he adds an argument for “laying the groundwork for recovery and future prosperity … [by] shedding Washington habits.” That implies no Congressional earmarks and other changes in the stupid way we’ve been allocating government resources for a long time now.
I have no problem with Summers’ arguments – as far as they go. However, as I never tire of repeating, long-term success requires fundamentally changing the way we save and invest, produce and consume, export and import. Such a transformation goes way beyond income relief and public investment, no matter how huge the number of dollars injected into the economy. We also need a big increase in private investment in plant and equipment rather than paper assets and estate. That will require, more than anything else, a wholesale revamping of the American tax system. Failing such a fundamental change in the incentive structure, why would a rational investor put money in production facilities in this country when competing nations offer far more attractive terms and conditions?
So, while pursuing relief and recovery, we need to give equal attention to a national strategy to restructure the American economy so that it can be fully competitive in global markets. To get that right, we need a clear, coherent vision of what that economy would look like -- and we need it soon. Otherwise, we’ll end up making a thousand uncoordinated decisions that so muddy the waters as to make subsequent transformative change virtually if not literally impossible. I’m hoping that’s what Summers meant when he concluded: “Far from being an excuse for inaction or delay, the magnitude of the work ahead is all the more reason to begin that work.”
Saturday, December 27, 2008
As the new administration tries to formulate its economic goals, it seems to be consciously aiming low. At first, President-elect Obama hoped to generate 2.5 million jobs in his first two years. Later, he upped the target to 3 million jobs. That would be better, but it’s still a rather paltry number and would hardly constitute a full recovery for
Consider the basic numbers:
--In November, according to government statistics, 10 million Americans were unemployed. That’s more than triple the current target for the next two years.
--The American economy has lost 2.6 million jobs since the peak in June 2007 for total private employment. In November 2008 alone, employment levels fell by 533,000. When December numbers are released, we may be close to or even beyond three million jobs lost in a year and a half.
--According to the US Department of Labor, the natural rate of increase in the work force is approximately 100,000 persons. Thus, every 24 months, 2.4 million jobs would be needed just to stand still.
--So, merely to get back to the June 2007 level will require 2.6 million jobs plus 100,000 for each month thereafter. Eighteen months later, we’re already 4.4 million jobs short – and digging deeper.
--By the mid-point of the first next administration the deficit compared to mid-2007 will be 6.8 million jobs.
When facing the worst economic crisis in 80 years, it may be good politics to lowball expectations. Of course, Obama isn’t the first politician to try to lower expectations. Recall that in far less challenging times Bill Clinton pledged to produce ten million jobs by 2000. It sounded bolder than it was (the natural increase in the workforce would have been expected to eat up almost all the 10 million jobs), and he overshot his target: while the civilian workforce grew by 14.5 million in his two terms, the ranks of the employed soared by 18.4 million. Unemployment fell by 3.9 million workers, pushing the unemployment rate to below 4 percent.
Monday, December 22, 2008
We all learned this basic accounting identity in school. C stands for household consumption expenditures. I stands for gross private domestic investment. G stands for government spending whether for consumption or investment . X – M stands for exports minus imports, or net exports.
If you want to increase national production and income – as we all do – you have only four choices: increase C, I, G, and/or X - M.
The Congress and the new administration seem largely focused on expanding consumption, even though excessive reliance on consumption-led growth helped bring about the current calamity in the first place. Until the rest of the economy recovers and credit becomes available again on reasonable terms, there is reason to question the efficacy of measures aimed at expanding household spending. Let’s hope they rethink this before pulling the trigger on the next “recovery” package.
They also seem agreed on a sizable increase in government spending. I’ve got no problem with funding “shovel-ready” infrastructure projects. Many are long overdue. However, realistically even such projects will take years to start and finish. Moreover, we need to do than just repair and rebuild our broken-down roads and bridges if we want to restructure our economy. We need to commit to massive new spending on intercity rail, electricity distribution, and broadband service, among other major public investments.
I’ve written and spoken a lot about expanding net exports without yet hearing any echo from the Congress or the next administration. But let’s face the facts: we owe the rest of the world a huge sum that grows daily by several billion dollars, even in this recessionary period. Replacing imports (especially energy) with domestically produced goods and expanding exports (particularly capital goods) are essential if we are to avoid settling our unbalanced accounts through a massive inflation.
The more “bail-out” money we throw around, the greater the risk of inflation and the sooner the day or reckoning. This is not so much an argument against doing what’s needed to stabilize the financial sector and key industries like the automotive sector (and don’t overlook escalating cuts in state and local government services and employment). Rather, it is a plea to use the recovery to rebuild the productive capacity of the United States.
Like government infrastructure projects, private investment projects produce jobs immediately, even before the new plant and equipment becomes operational. How to prime the private investment pump?
In my last post, I promised to propose a way to do so. Thanks to an op ed piece in this morning’s Financial Times, today I’m not alone in suggesting that the answer lies in the US tax code. Fred Smith,ceo of FedEx, urged that we use the leverage of expensing, that is, allowing private investors to write off their full investment in the tax year in which they incur the expense without any dollar limitation. Quite naturally, he sees spending $150 million on a new Boeing 777 is a “big risk.” “The best way to mitigate that risk,’ he argues, “is to allow the company to get that money back quicker. It reduces risk and encourages investment more quickly in equipment, facilities and jobs.” Smith cites tax experts Ernie Christian and Gary Robbins on the multiplier effect of expensing: for every dollar of tax cuts for expensing, the economy gains nine dollars of GDP growth.
Why not go one or two steps farther? Add bonus depreciation for investments made earlier as a means of accelerating the private sector’s decision-making. Instead of just 100 percent write-off, why not consider an extra 30 or even 50 percent in the first year to be reduced by ten percent in each subsequent year? Then lengthen the period for carrying forward losses so that future profits are sheltered by current losses including the expensing and bonus expensing.
The effects of such a tax approach would stimulate the economy in the short term. They would help restructure the economy in the medium term by expanding our productive capacity with state-of-the-art facilities. They would do so with no up-front government expenditure or borrowing. Government revenues would be reduced in the out-years, but they would grow in the near term and beyond as people returned to work to produce the equipment, components, and materials needed for each new investment. Construction and transportation companies would be revived at the same time. This approach maximizes the reliance on market forces and minimizes the growth of government buy avoiding new subsidy programs.
Finally, such a program would provide an outlet for nervous foreign holders of dollars. Investing in Treasurys that produce a negative real return is obviously only a short-run strategy for those with no other place to run to. Let’s use expensing to give them a reason to invest in America and, by helping us rebuild our productive capacity, to restore value to the dollars they continue to hold.
Thursday, December 18, 2008
A stronger dollar raises the price of US exports in terms of freely traded foreign currencies. Over time, that reduces our access to foreign markets. It also tends to lower the dollar price of imports, adding to our deficit. At the same time, a stronger dollar tends to lower the price of imported oil and gas and is more attractive to foreign suppliers of capital. It reduces inflationary and can spur deflationary pressures.
By contrast, a weaker dollar lowers the price of US exports and raises the price of our imports, reducing our trade deficit and the need to borrow to finance it. At the same time, it tends to raise the price of oil and gas imports and prompts foreign suppliers of capital to park their cash in some other currency.
So, it should be clear that any gains from dollar movements: 1) are accompanied by losses in other parts of our economic life; 2) are temporary and subject to reversal, perhaps even in the short-run; and 3) cannot be relied upon to solve our long-term competitive problems. (Mercantilist currency policies, a pet policy peeve of mine, are simply price-fixing schemes that subvert the working of free markets, thwarting the short-term adjustment function of exchange rates.)
To achieve lasting competitive gains, we need smart policies in all the areas that impact our trade performance. The on-going recovery and rescue packages under consideration are our best opportunity to get some of that right. If we don’t, we’re just wasting trillions of dollars that we’ll be unable to repay – a recipe for massive inflation.
In my next post, I’ll advance one simple idea for getting it right, starting immediately, without any up-front government expenditure, and in a way that maximizes reliance on market forces.
Tuesday, December 16, 2008
As huge as the scam was, it is not so surprising that personal greed overcame good judgment in a lot of people who might have and should have known better. What’s shocking is the extent to which reputable banks, insurance companies and other financial institutions fell prey to the same instincts.
That list is long and international: Belgium’s floundering Fortis Bank; France’s BNP Paribas which is supposed to rescue Fortis; Spain’s Grupo Santander; the Royal Bank of Scotland; Japan’s Nomura Securities; MassMutual’s Tremont; and more around the world.
Aren’t these the very institutions that are supposed to know all about risk? Don’t they make ordinary borrowers jump through hoops to provide detailed information and pledge collateral before lending sums that by comparison to the eleven figure fraud perpetrated by Madoff are paltry? Aren’t these the very organizations – the financial professionals -- that want to be entrusted with our money because they know best how to manage it?
By the same token, the performance of the Securities and Exchange Commission does little to relieve our fears. The SEC apparently was asked to look into Madoff’s empire in the 1990s and never launched an investigation. Aspiring crooks everywhere may draw the lesson that if the scheme is sufficiently complicated, your reputation impressive enough, and your political contributions well placed, the regulators can’t regulate and might not even try to.
The ongoing meltdown demonstrates that resolving liquidity problems may just be a matter of cash. Restoring confidence is another matter entirely in a financial system that has betrayed the values of honesty and integrity while celebrating “success” that turns out to be based on elaborate fraud and systematic abuse of trust.
Thursday, December 11, 2008
To make matters worse, the Treasury this week closed the book on eight years of missed opportunities by once again – for the sixteenth time – issuing a semiannual report to the Congress that failed to cite a single country for mercantilist currency practices. To be fair, the Clinton administration record after 1994 was no better. We might know obscenity when we see it, but some people just can’t detect currency manipulation anywhere by anybody despite a mountain of factual and statistical evidence.
In the meantime, Beijing seems paralyzed by internal dissensus on monetary policy. There is open talk from the top of the government about the need to stimulate domestic growth, to reduce the dependence on export-led growth, to keep inflation in check, and to meet the rising expectations of average Chinese for a viable social safety net, affordable homes, and more. The government constantly fiddles with tax rebates, export taxes, price controls, and credit restrictions; it loosens and tightens these crude policy tools in a frantic effort to keep Chinese economic growth on a stable path. Yet it constantly refuses to make use of the one sensible and available macroeconomic tool -- the rate of exchange for the renminbi.
There are many things about the Chinese I may not understand all that well, but I do know they respect strength. Not brute force, but a clear sense of national purpose and a willingness to stand up for legitimate rights and interests. Lacking that, diplomacy is just an empty exercise in rhetoric. Until and unless the US is ready and willing to back its often strong words with some meaningful leverage, “negotiations” over currency matters will produce no meaningful and lasting result.
As I’ve tried to express in earlier postings, five years of diplomatic dithering has produced no real progress toward rebalancing a dangerously out of kilter world economy. Rather, it has allowed a problem that in 2003 was essentially a bilateral trade problem to mushroom into a mammoth mercantilist threat to the world economy.
Thanks to a beloved former client, I have on my desk a small momento quoting Abraham Lincoln: “There is no lesson in the second kick of a mule.” I’ve been pondering this small bit of wisdom from our sixteenth president, wishing that somehow our forty-fourth president, an open admirer and close student of Lincoln, will benefit from the abject failure of his immediate predecessor to confront the currency problem. Let’s hope we don’t have to relive the past before we can escape it.
Wednesday, December 10, 2008
Yet on reflection, I’ve come to realize that Neil Armstrong is the wrong icon for what lies ahead us as a country. Instead, I’d propose Rosie the Riveter. After Pearl Harbor, she moved from the farm to places like Detroit after Pearl Harbor and used her brain and brawn to produce the hardware that won a world war.
The Apollo program was a national achievement, to be sure. It helped us catch up with the Russians’ lead in space technology, lifted our spirits after a botched invasion of Cuba, and helped the country get over a series of political assassinations that shook confidence in our democracy.
But what did Apollo require of us as individuals? Sure, some of our tax dollars were devoted to the space program. And we watched the big events on television, awestruck by the take-offs, splashdowns and that glorious July night adventure on the lunar surface. But we didn’t have to change a single thing in the way we lived, earned our incomes, or managed our expenses.
During World War II by contrast, we saved, conserved, rationed, reused, substituted, and melted down unneeded metal – all for the war effort. Ordinary people as exemplified by Rosie did extraordinary things. In a period shorter than the current conflict in Iraq, we won a global world and laid the basis for a period of spectacular growth and prosperity.
In the midst of the meltdown of the postwar system, we need to emulate Rosie and all the ordinary citizens who won the WWII on the home front. We need to change many aspects of our lives, learning new skills and developing new habits. While we’ve been profligate and irresponsible, these changes shouldn’t be regarded as a form of punishment or purgatory. If we see them that way, we’ll get over them as quickly as we seem to have $4 a gallon gasoline. Rather we need to dedicate ourselves individually and our country collectively to the pursuit of a new, overriding national objective.
As I’ve written before, the goal for me is clear: Invest. Produce. Export. Pay down our massive foreign debt. Organizing our policies and our personal behavior to pursue those goals will pay off in terms of better jobs, higher incomes, a cleaner environment, a legitimately strong dollar, a more secure country, and a legacy for future generations that we can take pride in. Like World War II, this is a challenge we must accept and conquer. And as Rosie would say: We Can Do It.