Bill Clinton calls the GOP's actions 'automatic'

“Those guys are on automatic,” Clinton said during an interview on CNN’s “American Morning.” “They have a — you know, you punch a button and they give you the answer they give you.”

His use of the description 'automatic' is interesting because it strikes me as a spot-on description of what the Republicans propose -- a market system in which tax cuts are the answer to everything. Except for their three Northeast senators, the entire GOP congress voted against the stimulus plan as 'big government.' In rejecting the plan, they used the same logic they've used since the early 1990s. The GOP wants to preclude economic planning of any sort, and put all their eggs in cutting taxes. When something happens, regardless of the conditions, the answer is the same -- lower taxes.

Anything different than that viewpoint is 'socialism.'

Now, I like tax cuts and believe they have a place in good economic policy. But a hypothesis of mine is that Americans are starting, slowly, to see that a theory with such dedication to its truth without regard to reality can't help but often be wrong.

In this sense, as knowledge, President Obama's stimulus plan represents the mind to use public logic and government institutions to counter socially destructive consequences of economic activity, especially those events that threaten the capacity for free economic activity in the first place. That it is good for markets to employ this more thoughtful understanding of how they work.

Monetary risk

It looks like tomorrow President Obama will sign into law the stimulus bill. It is a historic bill -- a meaningful re-distribution of wealth that contrasts sharply with the previous administration's approach to distributing wealth, especially their initial tax cuts. About this plan, the other day I wrote:

The argument against Obama's plan is that it exacerbates monetary risk.

The words 'monetary risk' represent a need for new categories of language and knowledge. The recent era of easy money was little concerned with monetary risk. Instead, the country has proceeded as if our monetary regime is beyond reproach -- we were, we are, the world's printing press, the thinking went, and so we can, if we choose to, create more and more debt. Or, as Dick Cheney, put it, "Reagan proved deficits don't matter."

The current contraction is ending this knowledge. Events are showing that America's ability to print money and finance huge debts is not endless.

It is time the words 'monetary risk' get bandied about more seriously when economists, social scientists, journalists, and businessmen and women talk. The sentiment behind the words should be in the minds of elites and publics alike.

But to this point, our ideas have not yet acclimated to this new knowledge, as this stimulus bill includes tax cuts instead of a way to pay for it.

That said, I still am for the stimulus.

More on the contraction of total consumer credit

Credit contraction of December 1990-June 1992:

19 months, 16.4 billion

Credit contraction of October 2008-Present:

3 months, 19.8 billion (data through 2008)

This is an interesting data comparison. I note the differing intensities of the contractions as well as the different durations of time (so far). If in 2009 and beyond we combine 2008's rapid rate of loss with 1990's length of time, we would have a nasty result.

Total consumer credit is now contracting

There is an argument against Obama's stimulus plan

And it is monetary. Will there there continue to be demand for financing our debt at the levels we are approaching? Due to how much we depend on foreign investment, one wise path might be to let our economy contract and focus instead on getting our monetary and fiscal institutions in order. The argument against Obama's plan is that it exacerbates monetary risk.

This argument to me is strong. For example, there is no plan to pay for the stimulus. In fact, it includes new tax cuts. According to Bloomberg yesterday, the Treasury is planning to incorporate three times as much debt in 2009 as in 2008. The question is not, where will the money come from. The question is, will we continue at these debt levels to get the financing we need? This question, and these factors, are considerable.

But in the end, I support the stimulus for the way it invests in key economic institutions: education, health, infrastructure, jobs, etc. It helps move private action away from a finance model toward a productivity model. This structural shift, stimulated by the Obama plan, will help stabilize the economy by offering new means of growth while we de-leverage from those incredible levels of credit that just collapsed. The plan invests in the American consumer, which, in economic terms, is the primary asset on the nation's balance sheet. Finally, I support the plan knowing the possibility that, to pay for this, we will have to raise taxes and interest rates in the medium term and, once again, put our house in order.

The question of the dollar

From Bloomberg News:

The Treasury will likely borrow a record $2.5 trillion this fiscal year ending Sept. 30, almost triple the $892 billion in notes and bonds sold in fiscal 2008, according to Goldman Sachs Group Inc. The New York-based firm is one of the 16 primary dealers. This week, the Treasury is selling $187 billion of bills, notes and bonds.

We are tripling the rate we create debt? $187 billion last week? Using more debt to deal with a crisis of too much debt has even the relevant actors questioning themselves:

Treasury Department and Fed officials want to ensure there are enough firms bidding at auctions to keep borrowing costs low after the total number of dealers dropped last year to the lowest amount since the network was formalized in 1960. The Treasury Borrowing Advisory Committee, a market group that works with the central bank, wrote in a memo released Feb. 4 that more dealers would reduce “the possibility of an undersubscribed auction.”

What might a string of these "undersubscribed auctions" mean for the dollar?

Is the US government making a huge, unsure bet? It seems we are acting boldly with little relevant experience guiding us.

George Soros on nationalization and the bank problem

Soros:

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.

According to this take, nationalization would be bad for peoples' wealth and retirement funds in the short and medium terms. But nationalization would be good for economic growth in the long term. Tough call. Source.

Thoughts on today's retail figures

--Looking behind the headline, at the data, this struck me:

Retail sales, Gasoline stations

January 2008: $41,894,000,000

January 2009: $27,016,000,000

That's quite a fall in gasoline purchases -- a drop of 36 percent in one year, three times as intense as the drop in retail sales overall. One of the important questions facing America's consumer economy is whether the auto industry (and everything that goes along with it) is facing a historic downturn. If so, this would mean a lot of things. One thing it would mean is that America's consumer economy would face a huge hole.

What would, or will, fill it? What are we going to produce and consume?

--As I see it, crucial, structural questions like what to produce and consume are now open to new knowledge, and subject to drastic change, rather than elite control. To me, the lack of elite control separates the current contraction from the others of the past thirty years. Events are forcing change upon powerful actors, often against their interests. The rich and powerful are right now 'de-leveraging.' The collapse of the debt economy we've had the past eight years is the collapse of a highly unequal distribution of wealth and power.

--Much of what is to come will be against the will of the people we have grown accustomed to thinking of as a 'power elite.' The imposition of President Obama upon the power elite, with little accompanying fuss, is just the beginning.

--Events suggest the American elite does not enjoy unilateral power relations with the rest of the world, either. Problems are happening to us, not because of us. We lack total control. The chaos with our banks is the most recent example. Iraq, Afghanistan, Pakistan, and Iran are also examples. As is the extent we depend on foreign purchases of our debt to finance our entire operation.

--Historically speaking, the most important asset on the US balance sheet is the American consumer, or at least it has been. A top priority of economic policy should be to re-institute the unquestionable status of the American consumer. Pump purchasing power into the middle-class through massive investments in education, health, energy, the environment, and other areas that we've under-financed the past few decades. The quickest way for the American power elite to stabilize their position is to quit spending money on war and themselves and invest in middle-class institutions -- jobs, families, universities, food, and energy.

January 2009 retail sales up about 1 percent

Click to enlarge. Data via Calculated Risk.

The small rise is good news, but the above data-image shows the trend is still downward. The 1 percent rise is barely perceptible. Still, could it represent a shifting trend? The great blog at Calculated Risk argues no.

One month does not make a trend change, and January retail sales are still over 2% below sales in Q4 - suggesting a further decline in Q1 PCE.

Regarding the sales numbers, here is the NY Times report. And here is the government release.

President Obama on nationalizing the banks. Paul Krugman on President Obama.

Terry Moran of ABC News yesterday interviewed President Obama. Whole transcript is here.

TERRY MORAN, ABC NEWS: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks?

OBAMA: Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

Paul Krugman uses his blog to respond:

Yes, Obama is impressively articulate and well-informed — and his response shows that he has actually considered the issue. It’s light-years better than what we’ve grown accustomed to in recent years.

But his two main arguments aren’t actually very good. Yes, we have thousands of banks — but the problems are concentrated in a handful of big players. In fact, the Geithner plan, such as it is, already acknowledges this: the “stress test” is to be applied only to banks with assets over $100 billion, of which there are supposed to be around 14.

And the argument that our culture won’t stand for nationalization — well, our culture isn’t too friendly towards bank bailouts of any kind. Yet those bailouts are necessary; and even in America they may be more palatable if taxpayers at least get to throw the bums out.

Oh, and not a week goes by without the FDIC taking several smaller banks into receivership. Nationalization is actually as American as apple pie.

Source.

Brad DeLong on the 'end of monetarism' and the limits of money-supply expansion

After World War II, laissez-faire economists had a big intellectual problem: the Great Depression. How could you argue for dismantling the post-WW II social insurance states and returning to the small-government laissez-faire of the past when that past contained the Great Depression?

. . . .

[Milton] Friedman proposed that with one minor, technocratic adjustment a largely unregulated free-market would work just fine. That adjustment? The government had to control the "money supply" and keep it growing at a steady, constant rate--no matter what. Since money was what people used to pay for their spending, a smoothly-growing money supply meant a smoothly-growing flow of spending and, hence, no depressions, Great or otherwise. In Friedman's view, if the task of monetary stabilization could be accomplished via technocratic manipulations by a non-political central bank, there would be no need for much of the apparatus of the post-World War II social insurance state.

In the 1950s Friedman's doctrines were considered way out there. But his Keynesian adversaries overreached, and claimed that clever governments could maintain price stability and a high-pressure economy with "full" (rather than merely "normal") employment. By the 1970s, it was clear they were wrong. Since then, advocates of expanded social democracy have been on the retreat more often than on the advance. By the 1990s, even left-of-center politicians had come to respect central bankers' mastery of the money supply, giving them a wide berth.

The power of Friedman’s theory was, in part, rhetorical. "Keep the money supply growing smoothly" sounds like it means to keep the presses in the Bureau of Engraving and Printing rolling at a constant pace, printing out a steady flow of pictures of George Washington. But that is not how "money supply" actually works. In economic reality, "money supply" means not just cash money but also credit entries the Federal Reserve has made in commercial banks' accounts at the Fed; plus all the credit entries commercial banks have made in households' and businesses' checking accounts; plus savings account balances; plus (usually) money market mutual-fund balances; plus (sometimes) trade credit and the ceilings between credit card limits and consumers' current balances.

No central banker controls all these vast and varied sluices of the money supply – at least not in economic reality. When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the "money supply." Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.

For the past eighteen months the collective central banks of the world have been trying as hard as they can to keep the deck of the ship level. Traditionally, central banks boost the money supply by buying government bonds from the Treasury for cash. Buying government bonds for cash cuts the supply of bonds the private sector can acquire, boosting their price while lowering interest rates, making businesses more eager to spend to expand and making asset holders feel richer and thus more eager to spend to consume.

The central banks and finance ministries of the world have purchased so many government bonds for cash that they have pushed the prices of short-term government bonds up as high as they can possibly go. With interest rates practically zero, there is no extra interest return to be gained in the short run from bonds. Yet it has not been enough.

So increasingly over the past year, the central ministries of the globe have taken extra measures: they have guaranteed debts, they have partially or completely nationalized banks, they have forced weak institutions to merge with stronger ones, they have expanded their balance sheets to an extraordinary extent. And yet this, too, has not been enough.

So now the central bankers have thrown up their hands, and asked for help to stimulate spending through tax cuts and government expenditures. Because they have run out of means to "keep the money supply growing smoothly."

Today, we have reached the end of the line for the Chicago view of financial deregulation. Friedman thought (a) that the central bank could exercise enough influence over the money supply to effectively control it, and (b) that banks and other financial intermediaries would be regulated tightly enough that what is now happening would be impossible. But he never resolved the tension between his view that banks need controls and the Chicago view that business must be unfettered.

Monetarism may well make a comeback -- as a doctrine that is good enough for normal times. For in normal times "keep the money supply growing smoothly" does appear to be a relatively easy task, a minor adjustment to laissez-faire that can be performed by a small number of qualified technocrats. Unfortunately, not all times are normal.

Source.

President Obama's understanding of the economy and the near future

From last night's press conference. It's a pretty coherent explanation about where we are, and where he sees us going. It may not be perfect in all regards, but it combines a specific reading of current events with a thoughtful nod toward long-term challenges.

Chuck Todd, NBC: Thank you, Mr. President. In your opening remarks, you talked about that if your plan works the way you want it to work, it's going to increase consumer spending. But isn't consumer spending or overspending how we got into this mess? And if people get money back into their pockets, do you not want them saving it or paying down debt first before they start spending money into the economy?

President Obama: Well, first of all, I don't think it's accurate to say that consumer spending got us into this mess. What got us into this mess initially were banks taking exorbitant, wild risks with other people's monies based on shaky assets. And because of the enormous leverage where they had $1 worth of assets and they were betting $30 on that $1, what we had was a crisis in the financial system. That led to a contraction of credit, which in turn meant businesses couldn't make payroll or make inventories, which meant that everybody became uncertain about the future of the economy, so people started making decisions accordingly — reducing investment, initiated layoffs — which in turn made things worse.

Now, you are making a legitimate point, Chuck, about the fact that our savings rate has declined and this economy has been driven by consumer spending for a very long time — and that's not going to be sustainable. You know, if all we're doing is spending and we're not making things, then over time other countries are going to get tired of lending us money, and eventually the party is going to be over. Well, in fact, the party now is over.

And so the sequence of how we're approaching this is as follows: Our immediate job is to stop the downward spiral, and that means putting money into consumers' pockets, it means loosening up credit, it means putting forward investments that not only employ people immediately but also lay the groundwork for long-term economic growth. And that, by the way, is important even if you're a fiscal conservative, because the biggest problem we're going to have with our federal budget is if we continue a situation in which there are no tax revenues because economic growth is plummeting at the same time as we've got more demands for unemployment insurance, we've got more demands for people who've lost their health care, more demand for food stamps. That will put enormous strains on the federal budget as well as the state budget.

So the most important thing we can do for our budget crisis right now is to make sure that the economy doesn't continue to tank. And that's why passing the economic recovery plan is the right thing to do, even though I recognize that it's expensive. Look, I would love not to have to spend money right now. This notion that somehow I came in here just ginned up to spend $800 billion, that wasn't — that wasn't how I envisioned my presidency beginning. But we have to adapt to existing circumstances.

Now, what we are going to also have to do is to make sure that as soon as the economy stabilizes, investment begins again; we're no longer contracting, but we're growing; that our midterm and long-term budget is dealt with. And I think the same is true for individual consumers. Right now, they're just trying to figure out, how do I make sure that if I lose my job, I'm still going to be able to make my mortgage payments. Or they're worried about how am I going to pay next month's bills. So they're not engaging in a lot of long-term financial planning.

Once the economy stabilizes and people are less fearful, then I do think that we're going to have to start thinking about how do we operate more prudently, because there's no such thing as a free lunch. So if you want to get — if you want to buy a house, then putting zero down and buying a house that is probably not affordable for you in case something goes wrong, that's something that has to be reconsidered.

So we're going to have to change our bad habits. But right now, the key is making sure that we pull ourselves out of the economic slump that we're in.

Source.

Geithner announces broad outline of new TARP plan. Dow falls 400 points. The depth of the liquidity crisis even more apparent.

--After getting raked across the coals on television all day, Sec. Geithner's performance today is now being given as the reason for the tank in the Dow today -- 400 points last time I looked. Sec. Geithner looks to have some broad ideas and little confidence, at a time when the expectation was that he'd have specific policies and some confidence that they'd work.

--I understand President Obama and Sec. Geithner's (et al) reason against just taking over the banks is that it would be politically tricky. Is what the Secretary, and by extension the President, are going through today any more politically palatable?

--Beside the unwillingness to just take over the problem organizations, the reason for the Secretary's poor showing is structural: the bad assets in question are that deeply illiquid. They have a de-stabilizingly low market value. At this point, Sec. Geithner doesn't want to pay market values, and he doesn't want to use federal money to pay above-market values. Being committed to do one or the other was necessary to having a fully formed plan today. He wasn't, there was no plan, and the whole operation lost credibility for it.

--Nationalization is the only option I see. They should get to work on it. President Obama is the most credible social force in the world today. Credibility is what the banks need. A perfect merger. Let Obama's administration run things, and may they be creative.

Sec. Geithner getting raked across the coals

CNBC anchors are having their fun tearing down a government official. And it is true that Sec. Geithner in his statements this morning still provides no plan to fix America's banking problems. However, my reading of the situation tells me there is a real good reason the Secretary has no plan: he won't consider the only viable one -- full, honest, and proud nationalization.

America's private banking system has no credibility: it doesn't lead to growth but contraction; it causes rather than solves social problems; and it is mired in terrible public relations. The banks' troubles are bringing down the whole country's operation, from consumers, to companies, to the Treasury. To save the whole, the banks must be made over. New institutions must be created. The only way to do this, that I see, is for the government to seize the banks' assets, let the bad banks fail, let the good ones struggle to maintain their existence, and put our knowledge toward new ideas rather than bailing out old ones.

Finally, you can't simply 'put more liquidity in the market.' The problem is not a lack of money, but a lack of money movement. Liquidity is a multidimensional construct, not a unilateral one. The confidence to lend and borrow depends on credible laws, credible organizations, credible people. The existing banks don't have any of this. New institutions are needed. In the new world of American capitalism, credibility is not announced, it is socially decided.

One nasty thing about public relations: it often distorts knowledge

Public relations are dominated by a corporate personality. The objective is to communicate the credibility of an organization; you are judged by how well you do that.

If it takes it, you will tear down the credibility of another to protect your client's credibility. You are a corporate entity.

All these steroid stories coming out of the national pastime remind me of this. Baseball fans and media-types tearing down the steroid users. The steroid users trading the names of scapegoats to save theirs. The Roger Clemens public battle was especially brutal.

I wish we'd stop playing a purity game on these athletes. I wish men like Roger Clemens and Alex Rodriguez would come out and talk about their use -- their motivations, their fears, the effects, would they advise others use? Knowledge like this, created in an environment of empathy and trust rather than demonization and shame, would be invaluable.

Instead, the public uses morals to decide its judgment. And the men and the organizations hire marketing teams to create environments around them intended to portray themselves as moral. All the while, this moral outrage obscures the chance for new knowledge.

I am against the TARP

On Friday I said I support President Obama's so-called stimulus plan. I don't, however, think the word stimulus is accurate. The system needs more than a stimulus: it is in need of fundamental shifts in the way it operates. Maybe I'll start calling it Obama's Structural Adjustment Plan (SAP). Anyway, what I think about TARP (the Wall-Street bailout) is this:

--The TARP money should not be spent bailing out banks that failed in such destructive, overarching fashions. The bankers aren't criminals or anything, and they can even keep the money they've gamed up to this point. But absolutely, no doubt, the banks should be allowed to fail. The system should be allowed to shift and adapt. The banks are a bad, and they have proven themselves such.

--As a result, full nationalization will continue to be a possible alternative of action. It is possible it will emerge as the only alternative. The banks have failed spectacularly and there is only a finite amount of political will to keep 'bailing them out.' If the banks don't turn themselves around soon, how much longer do they have? Furthermore, there is little confidence in the banks and in the consumer, and the environment necessary for stable liquidity and credible exchanges might be impossible with the same old bailed-out banks and over-bought homeowners.

-- So what should we do? We've been back-stopping the banks de facto since September anyway. So we might as well call it like it is: full nationalization, with the idea that a privatization will occur in the future, but with no set time-table. Also sensible, to me, would be to spend money re-writing the terms of the nation's housing debts. Re-investing in our middle class; in pure economic terms, creating again a stable basis of consumption and credit-worthiness.

Steroids and public relations: The first day of the A-Rod struggle

Remember the Roger Clemens steroid-user-public-relations battle last year? The back-and-forth that played out on ESPN and in the wide world of sports marketing? The A-Rod battle -- which got underway this weekend when it was reported that A-Rod failed a steroid test in 2003 -- could be even more interesting. The struggle to shape opinion commenced today, with a story on SI.com painting A-Rod as a sympathetic victim. The real culprit, according to the Sports Illustrated story, is the COO of the players union, Gene Orzo. Or as the article calls him, "a hardliner, a stonewaller and a zealot." A man who viciously did not destroy the evidence of A-Rod's failed steroids test. Hey, it's not personal, Mr. Orzo. It's public relations.

A-Rod's team finds itself in a contest for A-Rod's credibility. It is going to be fierce for the next few days and weeks. Once an opinion gets socialized, it is tough to reverse, so A-Rod's team knows it has to go hard and smartly, but also immediately.

I doubt going after the head of the player's union will be the crux of their case. But getting a reputable sports site like Sports Illustrated to publish this flimsy a hack job in your favor is priceless.

But if you're interested, turn on ESPN at some point tomorrow afternoon. My guess is you'll get to see a lot of sports media people decide the future of A-Rod as a credible athlete whose records and exploits are to be admired, rather than tainted, or even scorned. Chances are you'll here the words 'purity of the game.'

I've never met A-Rod, nor have I ever rooted for him or against him during his at-bats. But I can't help but pull for him here. A person's reputation shouldn't be up for just anyone to grab. Have you ever watched sports media? It's often entertaining, it's often informational and sometimes even provocative. On the balance, it's great. But these men who play sports experts on tv should be nobody's jury.

Thirty years of what? What have we been producing? What have we been doing?

While I support the stimulus bill, the whole talk of 'stimulus' is absurd in the first place. The American economy needs something far more complex than stimulus -- it needs significant structural adjustments.

For example, was this really sustainable?

Re: American economy

Number of goods-producing jobs in 1975:

21,974

GDP: 1.638 trillion

Number of goods-producing jobs in January of 2009:

20,245

2008 GDP: 14.281 trillion

In sum:

2009 sees 1.729 million fewer goods-producing jobs than it had thirty four years later, even as GDP has grown almost nine times over, by almost 13 trillion. Where did that growth come from if not from producing goods?

From the production of money, that's where it came from. But the era of producing 'money' is over, and to a large extent so is the consumer age. So now America needs to figure out the kinds of 'goods' that it is going to produce in the period to come, and create jobs designed to produce those goods. Luckily, the era of money taught us that the nature of a 'good' is wide open. I am hoping President Obama's so-called stimulus will provide the basis of a transformation, putting significant money into education, health, and infrastructure. My vision is we begin to produce these 'goods' at a rate that can carry the economy into the future, doing so on a more sustainable basis.

News Corp. in trouble

From CNBC:

NEW YORK (Reuters) - Rupert Murdoch's News Corp posted its biggest ever quarterly net loss, after taking an $8.4 billion writedown for the value of its Dow Jones acquisition, broadcasting licenses and other assets.

Excluding the charge, the results missed Wall Street forecasts as the recession exacerbated the fall in newspaper advertising sales and hit the company's other properties.

News Corp shares fell 6.3 percent to $6.50 in after-hours trading and have shed about 65 percent of their value in the past 12 months.

"It is the worst global economic crisis since News Corp was formed 50 years ago," Murdoch, chairman and chief executive, said on a conference call with analysts.

The unemployent rate hits 7.6 The U-6 hits 13.9

This data-image shows the U-6 rate from 1994 until January of 2009. Source.

The U-6 rate measures "total unemployed, plus all marginally attached workers plus total employed part time for economic reasons, as a percent of" the labor force. It's the closest thing we have to a percentage of employable working-age people (over the age of 16) for whom the economy is not producing a full-time job.

I am for the stimulus

Four thoughts:

--I support President Obama's so-called 'stimulus' plan as a government-spending program that is intended to re-distribute wealth to the middle-class. I support it for the purpose of (1) enhancing the productive job market, and (2) re-growing the most dependable consumer class in the world, one of America's most important assets.

--I believe the supply-side experiment is over. It met the objectives it laid out for itself: grow the economy and keep inflation in check. It did that. But new conditions call for a new experiment.

--The stimulus and the TARP are not the new experiment, they are transitions toward it. The new experiment is, to the best of my reading, still open-ended.

--I keep close in mind that President Obama has Paul Volcker sitting next to him. For some reason. That reason strikes me as obvious: to sooner or later unleash him. As soon as we turn the contraction to growth, if even slightly, what would be the plan if not to unleash him? That means higher interest rates, and higher tax rates, to bring down the deficit and strengthen the dollar. I don't think the 'deficits don't matter' approach that we see right now will last beyond the contraction. In fact, I think the approach will rapidly swing the other way, via Volcker.

The problem of wealth re-distribution

In this country, when men and women with any publicity talk about economics, the idea of 'wealth re-distribution' is pre-conditionally rejected. No serious commentator can be thought to be a re-distributionist. So, except for Republicans who use the word to accuse their Democratic counterparts, nobody brings the idea up. As a result we never talk about the idea in a serious manner. We talk about economics as technical, but the distribution of wealth as ideological. Public communication continues to be dominated by a dogmatic -- rather than an empirical -- approach to wealth. This is a problem for two reasons.

1. It reduces confidence in the efficiency of the market. Under some conditions, it is simply possible that re-distributive policies have their technical merit. The supply-siders know this: much of their credibility stems from their willingness to say precisely how their distribution of wealth -- tax cuts -- leads to efficient markets: by increasing the incentive of economic actors to generate wealth. The demand-siders tend instead to use a moral, justice-based approach. They are not as proficient in explaining how their spending programs will lead to growth. Right now President Obama should be explaining how the bill will re-create -- 're-grow' -- a vibrant middle-class of consumers. He should not call it stimulus, but a major growth package.

2. The big reason this narrow communication pattern is a problem is because it's false. Any activity by a givernment impacts the distribution of wealth. They print the money. They determine the interest rate at which they give it away. They choose who they give it to. Tax cuts, tax increases, spending programs, spending cuts -- these are all major factors in who gets their hands on America's wealth. The evil of re-distribution is a false myth we tell ourselves. Re-distribution is a banal reality. I have no problem with myths. Every society holds them. But what good are they if they ring so damn untrue?

Finally, it is remarkably brazen that at this moment we hear cries of redistribution. Are we not aware that America's wealth is now socially owned? That this massive nationalization -- we still don't quite call it that -- happened during a Republican administration? I can't help but think this American form of socialism is here to stay for a while. The need to admit the fact of re-distribution, and tackle it in a sensible and technical matter, is as great as ever.

Economic theory and the GOP

From the point of view of their own interests, it strikes me that the GOP could use a new theory of economics. The free-market model they are used to has lost immense amounts of credibility, and the future doesn't look any better for the increasingly worn doctrine. Does the GOP want to be the party of a few faithful surrounded by many adapting to new conditions? What happens when the few faithful pass along? What will be the GOP's public base? Can it stand on religion and war alone? What happens when the meaning of religion and war change? Will they get passed by while standing for 'principle' there too?

However, I agree the circumstances are tricky. The GOP should not want to jeopardize its closeness to America's power elite, which to me is the only reason the GOP would want to maintain the silly free-market message that the elite appreciate so much. But power relations are not everything. The GOP needs national public support, too. Because of this need, I tend to think the GOP should search for a new economic message, one that can resonate with increasingly reasoning Americans.

Credibility

To me, a real handicap of economic theory is that it has no way of studying the role of 'credibility' in helping determine economic outcomes. In any given economic context, the need for credibility on the part of the actors shapes the behavior as well as the consequences of the behavior.

For example, a few months ago the WSJ reported (in an article I fleetingly read and haven't found again, either on-line or hard copy) that a significant part of Sec. Paulson's reasoning for letting Lehman fall back in September was to maintain a semblance of free-market orthodoxy, particularly for public relation reasons. At least that was my reading of part of the report. (But again, I haven't tracked it down to read it again and confirm that.)

I found that provocative. Here's the Secretary of the Treasury, determining fateful Treasury policies -- the decision to let Lehman fall led to extraordinary consequence -- according to whether they conform to the sacred truths that the American public tells itself about their 'free markets.'

On one hand, it would probably suit us well to find a more realistic theory about our economy, if what we think actually matters for policy.

And on the other, it is remarkable how significantly public credibility shaped the Treasury actions in the first place. This is a good thing, but a scary thing, too. It's democracy, or at least democratic.

But again, if major economic actions are going to be decided, at least in part, according to the habits and truths of the public sphere, then it would suit us well for public knowledge to be updated and then disseminated more broadly, so we can think in new ways, to fit these new conditions. Economic theory, in other words, has a lot of work to do. It has to create new knowledge, and then disseminate it as new habits.

This is why when I view the perfect stimulus package I see it being an investment in American education. If the public is so important, we probably should get smart(er).

Questions and comments

Re: Obama's stimulus

--It shouldn't be called a 'stimulus.' It should be called a government spending program, and conceptualized as a significant shift in the distribution of the country's wealth.

--I liked the first picture of the plan I saw, as laid out in the WSJ on January 15th. A lot of money to states, education, and infrastructure. To me it looks like a distribution of wealth in the direction that the American economy needs to re-balance things. The goals should be to push capital toward productive rather than merely financial activities, and create a viable middle-class of consumers.

--A slightly worse plan than this first one will finally get passed. The Republicans are playing politics rather than giving good-faith arguments about the future of America. But probably we're all doing that, more or less.

--We should pay for the spending program with a repeal of the Bush tax cuts, with the compromise to transition back to the Bush tax cuts within six to ten years, after necessary stabilization happens.

--Short of such new tax revenues, get ready for extremely high interest rates. The government remarkably resembles a broke entity, even though we all know it runs the world's printing presses.

--This contradiction interests me. If, by the design of the system, we have all the money we need at our fingertips, why do American banks, American consumers, and the American government appear to be broke?

--Does the world live by new rules? Does our liquidity crisis mark the end of the old system?

--How can we learn a new system, when we've barely begun to understand the old one?

--Or is the American consumer still king as soon as the world recession turns around?

If so, the old system remains. If not we live in a brave, new world of consumption, in which we are no longer the king, but a powerful entity among others.

Why is there still a liquidity crisis?

What, precisely, is going on with the banks?

With all the money the government has pumped into banks via auctions and direct capital injections, why are they still worthless as organizations? The dollar is a viable currency. We are giving billions of these dollars to our banks. Why is this having minimal effect? Why aren't the banks yet lending money? Or are they?

Without a plausible answer to why the banks are in trouble even though they have all the money they need, thanks to the US government, any explanation of the current economic problems strikes me as hollow.

What have the banks done with all the money they've been given? Didn't they use it to pay down their debts? To the contrary, we still hear that the banks are bogged down in bad debt. What happened, then, to the TARP money?

I think there are at least three possible explanations why, despite the TARP money, the banks continue to face liquidity problems:

1. There is a 'confidence' crisis. In this case, the banks are better capitalized now, but maintain the bad assets on their balance sheets. As a result, despite the capital, there is little trust in lending to US consumers and other banks, at least until these assets are given a price. Moreover, for the same reasons, foreign lenders lack confidence in US markets. The pertinent questions become: When will these assets be given a price? How far will these bad assets come down? And will the prices by then be high enough to re-gain our credibility as borrowers? In this scenario, we should do the stimulus now, the TARP later after stimuls raises the prices of the securities.

2. There is a 'jobs/actual-wealth/actual-productivity' crisis. Nobody has the hard income or the physical wealth to sustain the borrowing that went on the past few years. We are significantly poorer as a result of de-leveraging, i.e. the marking down of debt. At a historically normal level of credit-worthiness, very few Americans and American organizations now qualify in terms of hard equity. Again, the solution is demand-side -- we need to build a consumer class again.

3. The banks are lending the money. The TARP money is going (or has gone) straight into the US bond market, which accounts for the bubble in the yields on Treasuries. And therefore there will be a need for more TARP money, because the bad debts have barely been touched. In this scenario, investors are wondering how long the US government can stop-gap Wall Street, because Wall Street is currently stop-gapping the US government.

If the problem is confidence, then I think the banks are under-priced. If they have the capital to wait it out, a stimulus plan can slowly re-value the price of those bad assets. Once we gain evidence of a strengthened American consumer, these assets will be more valuable than they are right now.

If the problem is jobs and wealth -- the lack of any real productive wealth-building for the past three to four decades -- then I say we have the stimulus plan twice over, minus the tax cuts, paid for by a repeal of the Bush tax cuts. Let's invest in America's productivity again.

If the problem is that the TARP money went into treasuries, that means the money went to make more debt rather than pay down debt. To put it mildly, this is a more complex issue. To put it less mildly, this is potentially a harbinger of even bigger problems. For example: Is this putting the Treasury at risk of a default? Is the only thing worse than depending on China, depending on Wall Street?

If it's any two of those three -- a shift in the direction of economic confidence; a lack of jobs, productivity, and actual wealth on the balance books; or a dead treasury -- or god forbid all three, wow: we are short of the middle of a deep contraction and a difficult recovery.

Can nationalization be worse than this?

Ok, I get the argument that, on purely theoretical grounds, 'nationalization' is a dirty thing that should be avoided at all costs.

But even at costs like the ones we are seeing? At some point, doesn't the reality of consequences overwhelm the socialized logic of the sacred free-market?

When I say the costs we are seeing, I mean examples like this: The US government has back-stopped over $150 billion of AIG's debt. I checked today. AIG's market cap is barely $3 billion. This means the government is backing AIG at 50 times its value. Is this fully-dependent-but-still-private relationship preferable to full nationalization?

For that's a lot of debt we are assuming, and will have to pay back. How about if a little control comes with that full financing?

Right now, the AIG numbers tell us, the government is running the show on Wall Street. At the moment, we do not have a privatized banking system. Anyone who thinks this is a bad thing, should stop trying to 'preserve' a privatized banking system and start trying to 'recreate' a privatized banking system. What kinds of new institutions and institutional practices will be needed in this re-creation? This is a question we should be asking. For nationalization may not be the truth we want to tell ourselves, but it is the reality of the moment before us.

It strikes me as reasonable that, because of this de facto government ownership, a far more complete national discussion about the practices of these banks should be going on. Right now we have a hybrid approach: complete government financing, with little public oversight. This is generally accepted as the way to run neither a democracy nor capitalism. We have the worst of both worlds. In capitalism, bad firms are supposed to go under. Not in our case, and I generally agree. In democracy, the public is supposed to ask questions thus letting better information and better overall understanding emerge. Questions, such as: Why do the executives still get crazy bonuses? Why do they even have their jobs still? What are the banks doing with their capital injections? We lack this second part, and our plans are suffering as a result.

To me, as a result, this whole crisis is beginning to look like a mess. We should immediately move to create a better decision-making process than the one the country has so far used. We can start by giving more data to the public so the public can better understand the elite's actions. I want to know this: Where is the TARP money?

As a society, we can't control the outcomes of the plans we put in process, or the problems that will emerge. But we can control the methods we use and the reasons we come up with to generate the plans and respond to the problems.

Reinhart and Rogoff: Are we looking at another 5-7 years of economic slump?

Two economists articulate why the current contraction could last a total of 5 to 7 years. The main reason: America's debt, already $10 trillion, could double due to the current crisis. Reinhart and Rogoff report:

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession. Aggressive countercyclical fiscal policies also play a role, as we are about to witness in spades here in the U.S. with the passage of a more than $800 billion stimulus bill.

Needless to say, a near doubling of the U.S. national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates and a collapse in today's bond-market bubble. The legacy of high government debt is yet another reason why the current crisis could mean stunted U.S. growth for at least five to seven more years.

Source.

US-China: Five to ten years from now, which consumer base, relatively speaking, will have gained or contracted as the basis of the world economy?

The WSJ had a story yesterday headlined, 'Global Search for Growth Will Turn to U.S.' The focus of this article is a question -- who will the world economy rely on for its consumer base, more specifically, will America remain that base or will we contract relative to others as the only indispensible consumer? As I see it, the answer will have a lot to do with where America sits, economically and socially, in five or ten years. The question is up in the air because America just created a global recession that threatens to turn into a world depression, just as other nations are developing new consumer bases, i.e, China. You never want to piss off the world, but especially not right as an alternative to you is in the process of emerging.

So, what do we know. We know there will be a fierce contraction this year and next, and then a slow recovery will take over after that. Let's call that a total of three or four years. What about year five and beyond? What about the medium-term?

One deciding factor about year five and beyond could be whether the US remains by far the most significant consumer basis in the world. Right now there is the thought that China might eat into that significance. So the question is, while the US will remain the most important, will it remain as important, as central, as unilaterally determinative? That, we might say, is another question. If China eats into American demand -- in other words, if the world's producers, investors, and bankers transfer a certain amount of the world's business to China as their population, already enormous, creates an-ever growing middle class of consumers that, just by numbers, could swallow us Americans -- our standard of living will go down. We will have to produce more and consume less. We might even feel it, and it will make our lives different than they are now, and have been. Specifically, it would be less access to easy money and less than limitless consumer items.

Of course, the above scenario is but one alternative. The WSJ article suggests another. The article reports the world's elite believe the system still depends on American consumers, and bad. I gotta say, whether they are right or wrong on that, this WSJ story is fabulous. It uses the word 'elite.' I get disappointed when people shy away from using it, in a sociological way. I don't like the political use of the word -- as if anybody should be ridiculed because he or she's an elite. But when just talking about how society works, the word, or something like it, is necessary. Anyway, here's an excerpt and the question is: what do elites think?

Two questions preoccupy the world's economic elite here: Will the government money pledged to prop up national economies be enough to keep the world from going into a prolonged slide? And where will the growth come from, once bottom is touched?

At the start of the five-day World Economic Forum, the broad outlines of answers are emerging. Economists say the fiscal-stimulus packages from Washington to Beijing will cushion the downturn but fall short of preventing a world-wide recession. And global growth, when it comes, will still be powered in part by U.S. consumers -- though they'll spend far less than they did in the debt-fueled years of the recent boom.

Chinese Premier Wen Jiabao, the first Chinese leader to attend a Davos meeting in the event's 38-year history, will likely seek to lower expectations that China can extract the world from the economic crisis. Despite its rise as a global production hub, China -- like emerging Asian economies such as India -- is too small, too poor, and too export-dependent to provide much of a buffer for the global economy in the next few years.

Asia's inability to compensate for the drop in U.S. consumption means any global recovery will be slow in coming and marked by lower growth rates than the world has seen in recent years.

But again, the real question with US-China and who is the world's consumer is not today. It is five, ten years from now, and beyond.

Quote of the day: William James

The truth of an idea is not a stagnant property inherent in it. Truth happens to an idea. It becomes true, is made true by events. Its verity is in fact an event, a process: the process namely of its verifying itself, its veri-fication. Its validity is the process of its valid-ation.

William James, Pragmatism, 1907. As printed in Pragmatism: The Classic Writings, edited by H.S. Thayer.

If we think of free-market ideology as truth, we can say this truth was socially verified with the fall of the Soviet Union in the late eighties and early nineties. Following that event, the dominance of the free-market ethos became highly entrenched as recognized knowledge. But now, due to more recent events, the verity of the free-market is coming back into question. It is up to the human mind, the social mind, to decide again whether the truth of the free-market fits the reality of the events before our eyes.

In this way the debt crisis, the credit crisis, the housing crisis -- all these crises are simply, and complexly, a crisis of knowledge, wherein the truth we thought we knew about economic reality fails to meet the challenge of present-moment events.

The turmoil we are experiencing is the fact that we seem to be facing a situation in which our old truths are just that -- old. We must develop new truths, new knowledge, and thus new reality.

This is the pragmatist theory of how social change comes about -- when our mind recognizes that the truths we tell each other don't fit the fact of reality. We then develop new truths or new realities, or both.

Economists confounded by the social fact of 'confidence'

Here is Robert Schiller writing in yesterday's WSJ:

President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits that is underway and may continue to worsen.

The term "animal spirits," popularized by John Maynard Keynes in his 1936 book "The General Theory of Employment, Interest and Money," is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people.

Here is John Cochrane, dismissing 'confidence' as a tenet of economics knowledge:

[Some] say that we should have a fiscal stimulus to “give people confidence,” even if we have neither theory nor evidence that it will work. This astonishingly paternalistic argument was tried once with the TARP. Nobody could say how it would work in any way that made sense, but it was supposed to be important do to something grand to give people “confidence.” You see how that worked out. Public prayer would work better and cost a lot less. Seriously, as social scientists, economists don’t have any special expertise to prescribe what intrinsically meaningless gestures will and will not give “confidence,” so there is no reason for anyone to listen to our opinions on that score.

Truth is, both Schiller and Cochran are right: 'confidence' -- or whatever you want to call the social-psychological category -- is both central to being able to understand or explain economic processes, as Mr. Schiller argues, AND peripheral to present-day economics theory, models, and concepts, as Mr. Cochran argues.

Indeed, to gain insight into 'confidence' -- and I agree with Mr. Schiller, via Keynes, that economics should try to gain such insight -- economists would have to be willing to turn to sociologists, whose well-established categories like legitimacy, power, authority, habit, the lifeworld, social structure, and interaction could help the economist learn a thing or two about the variabilities of human behavior and thought.

I read economists as much or more than I read sociologists. I value their knowledge. But I have a working hypothesis that their theories are not up to the task of understanding present problems. The chief culprit is their disinterest in the human mind and its social context. I also sense that economics practice suffers from a certain level of arrogance. This arrogance will not suit them well in a period like the one we are all of sudden in -- in which economics needs help from the very fields of knowledge they define themselves against.

Target Corp. to lay off workers, continue the 'job crisis'

I write this from the Twin Cities, where Target Corporation headquarters itself in downtown Minneapolis. Today, CNBC is reporting that Target is laying off an undisclosed percentage of its corporate workforce. My heart goes out to the unfortunate, and to the company itself: I am sure they would rather not lay off the men and women who make their business possible. My heart goes out to the 65,000 thousand or more workers to be laid off after yesterday's news. And to the 2.6 million workers who lost their jobs last year.

While certainly much of this is due to the 'credit crisis' -- there are fewer consumers and companies have less valuable debt than before the credit crisis -- can we at least begin to understand that the underreported story not just of the moment but of our era is the problem of jobs? For credit/debt levels -- as low as they are -- are only returning to historically normal levels. Now that seems like a kick to the head, but only because the past few decades, and especially the current one, saw credit/debt levels in this coutnry hit almost unthinkable levels. So the credit crisis is about a year, year and a half, old.

In contrast, the jobs crisis is decades old - I would argue three, almost four decades old to be exact. The extension of credit has allowed our economy to grow without great jobs numbers, and the globalization of capital flows and production sites have put a downward spiral on wages, with the benefit of lower prices. So we've had this: More credit. Lower prices. Good, and good. Fewer, lower-paying jobs. Bad. The truth is, if more Americans had had better jobs with higher wages, we wouldn't have had to extend so many bad loans. And thus we wouldn't have a credit crisis right now.

Perhaps that's good logic, I don't know. Maybe my heart is in the way of good analysis. Again, I don't know. What I do know is there are a lot of families today wondering where the bread is going to come from.

I understand we need to get credit flowing again. But it's been far longer that we've needed to improve the job market.

Good luck everyone, and may we develop new knowledge to deal with these present problems.

Consumer confidence hits new low (again)

From Bloomberg:

Confidence among U.S. consumers unexpectedly fell in January to a record low as job prospects remained dim. The Conference Board’s index of consumer confidence fell to 37.7, from a revised 38.6 in December, the New York-based private research group said today. Records began in 1967.

A low confidence number doesn't mean the economy is bad. It means the economy's members think it's bad. In other words, right now the system and its elite participants are having a hard time successfully marketing the system's virtues to its mass participants. That could be because there are no virtues to market. But that doesn't sound right to me. What about marketing future growth? Marketing the idea that once the recession is over the future will again be bright? I mean, when has this not been true of America? 1946-1970 -- the era immediately following the Great Depression -- is often referred to as the Golden Age of Capitalism. Instead, the historically low confidence number tells me that the economy's members question -- or even doubt -- a similar breakthrough following the current downturn. This, to me, is significant. For it would truly be a sea-change in the history of mankind if the American economy didn't turn back up at some point in the near- or medium-term future. Is this sea-change what we are currently living through? If so, the confidence numbers are spot on. If not, then we need to get a collective grip, survive the downturn, and build new institutions that will re-grow the wealth we have lost and will lose over the next few years.

In any event, the social-psychology of the system's membership is what 'consumer confidence' measures. It does not measure the economy's fundamentals themselves. Now, the fundamentals matter, because it is those fundamentals -- job prospects, credit prospects, inflation expectations, investment futures -- that the members are interpreting when they describe themselves as confident or not.

Housing price data, via Calculated Risk

Even after dropping more than 20 percent from their peak, housing prices are still much higher than what might be thought of as a more normal historical price trajectory. That is, housing prices could conceivably go quite a bit lower. Which means the question is: How much lower? Which really means: How much more wealth will America's families lose?

The data-image is from Calculated Risk, here.

Gold: A political reflection

I notice this morning that gold is back over $900. As you can see from the above data-image, this is just about a historical high-point (the above data-image only goes through about 2006). However, it is interesting, a bit of a curiosity in fact, that gold is actually lower today than it was a year ago, that is, lower than it was prior to last March, before the Bear Stearns collapse, and before the major interest rate slashing and monetary easing of the Fed. Due to the loose monetary policies of the past twelve months, we might, theoretically speaking, have expected the price of gold to have risen the past year, perhaps dramatically. Instead, it's stayed even, and actually dropped a slight bit. But still: that chart above is fascinating, in light of the fact that all the investors who since 1971 have poured their money into gold and driven up the price are, in effect, betting against the dollar.

One other thing about the data. Notice how the price of gold hits a high in the seventies before dropping from 1980 until 2000. Then look at the rise of gold this decade, under the economic stewardship of the Bush Administration. Remember: the high price of gold reflects, among other things, a percevied instability of the dollar. So the high price of gold is, as i see it, another reason to laugh at modern-day Republicans who consider themselves 'conservative.' Besides the attempt to radically re-make America into a fundamentalist paradise, and the unleashing of war to re-make the planet into a tyrant-less world, Republican monetary and fiscal policies have been similarly radical. The price of gold reflects the de-stabilization of the US economy during the recent Republican rule. There is little doubt gold is up and the dollar weaker because of the wild foriegn and domestic policies of the previous administration.

I am sure I am missing something, and perhaps I am over-reacting to the mangled and moronic radicalism of the Bush Administration, but my thesis that President Obama is the first real conservative president since Eisenhower just seems accurate to me. The ironic thing is that he is a conservative who markets himself a progressive (using the single-word mantra, 'change'), while everyone else since Eisenhower strikes me as change-oriented, power-grabbers who call themselves conservatives, or in Clinton's case, a 'New Democrat' (i.e., a conservative Democrat).

I do hope the Republican Party dedicates itself to a more sophisticated reading of political philosophy, and thus a more learned understanding of what it means to be a conservative. The country really could use a force for stability. The utopia vision of the Bush years should be put squarely into history. Maybe then we'd see gold prices go down, and confidence in the dollar -- and in the US economy -- go back up.

An interesting reader comment

The following comes from a reader, Adam Rafalovich. It's an interesting, if extremely downbeat take on the US economy, its recent past, and its coming future. I am doing a few other things at the moment, so I will give it a response in the morning. For context, he is responding to my take on the economist Kenneth Rogoff's call to deliberately inflate the dollar as a way out of the current mess. Yikes!

From Dr. Rafalovich:

Very solid points! Let me offer some additional comments:

The primary problem with the perhaps trillion dollar economic stimulus is its HIGHLY inflationary nature. To fund this stimulus requires the offering of even more US debt and a possible collapse of the US dollar. Embarking upon this stimulus (in addition to the TARP funds—half of which have been used, the other half, who knows?) risks serious usurpation of individual buying power and, of course, individual wealth. Who is to guarantee that other countries are going to keep the US dollar around as a reserve currency? What is the saturation point for those who hold US debt?

While I agree that something has to be done, if the post-stimulus economy does not "grow its way" out of this massive debt-issuance hurdle we might be in Argentinean, even Weimar Germany territory.

With that rather ominous statement let me state what I think is going on with the US economy:

I believe that we are BEGINNING (I laugh when economists predict the end of the recession in the middle of this year!!) a protracted period of economic restructuring. We may call this a recession, depression, whatever. The reality is that the level of consumer indebtedness in the US that gave the middle class the illusion of wealth for the last 25 years (thank you Mr. Reagan and Mr. Greenspan!) will come down drastically. We have now come to the end of easy revolving credit and the “house as ATM machine” refinancing craze. There will NOT be a resurgence of the US consumer sans a war, or some other consolidation of US economic power. The US consumer is done, and that is that.

Home prices are so far out of whack with median income, we still need an additional 20-30% correction in the housing market for people to afford homes again. Difficult-to-attain credit, job losses, and stagnate or declining real wages are all viciously feeding into this housing market correction. Also, let me add here that the fact that this whole thing “began” with the housing implosion and therefore must be corrected through a revitalization of housing really underscores the fundamental problem here in the US: HOUSING IS ALL WE HAVE!

Discard the drivel from the “Big Three” auto manufacturers that have provided a case study in outsourcing and do not have near the economic importance that they had a generation ago.

Discard the 1990s neo-liberal lie that we now live in a “new economy” where we can “sell” knowledge.

Finally, discard the idea that developing nations have “decoupled” from the US in this great experiment of global capitalism. When we cough, the UK gets the flu, India gets small pox, and China gets bubonic plague. And, right now, the US economy is in intensive care!

Again, the problem is that we don’t make anything in this country anymore. Neo-liberal policies have forced us to move all of our eggs into the housing basket, which has become a source of wages (through housing-related jobs), consumer spending (through tapping home equity lines of credit), and retirement (through paying a hefty mortgage, selling one’s house and moving someplace cheaper). This is the primary reason for Bernanke’s lowering of the federal funds rate and target rate, and the reason that the US government (that is, with a little help from our tax money!) is now engaging in the unprecedented and dangerous process of buying mortgage backed securities. The idea is that if you make money easier to get and mortgages more safe, mortgage rates will go down, which is exactly what they have done. But this misses a fundamental problem: artificially inflating asset prices is unsustainable and this will ultimately come home to roost, not with the wealthy, but with wage-earning, middle-income families.

Because housing is all we have, if we allow this correction to move through its natural course, you will see individual balance sheets virtually destroyed. The Fed cannot let that happen because that would necessitate an even great stimulus, the issuance of even larger amounts of US debt, and a further weakening of our currency.

Thanks for listening!!

Best Wishes,

Adam Rafalovich, Ph.D.

Sociology Department

Pacific University

Thanks!

Iraq: A war lost and a presidency failed

The famed and amazingly well-connected Washington journalist Bob Woodward has an interesting article here. In it, he lists ten lessons for President Obama to learn from what he calls the "troubled presidency of George W. Bush." Here's the first thing:

1. Presidents set the tone. Don't be passive or tolerate virulent divisions.

In the fall of 2002, Bush witnessed a startling face-off between National Security Adviser Condoleezza Rice and Defense Secretary Donald H. Rumsfeld in the White House Situation Room after Rumsfeld had briefed the National Security Council on the Iraq war plan. Rice wanted to hold on to a copy of the Pentagon briefing slides, code-named Polo Step. "You won't be needing that," Rumsfeld said, reaching across the table and snatching the Top Secret packet away from Rice -- in front of the president. "I'll let you two work it out," Bush said, then turned and walked out. Rice had to send an aide to the Pentagon to get a bootlegged copy from the Joint Chiefs of Staff.

Bush should never have put up with Rumsfeld's power play. Instead of a team of rivals, Bush wound up with a team of back-stabbers with long-running, poisonous disagreements about foreign policy fundamentals.

Speaking of Iraq, if you listen to official-Washington speak you hear things like 'the Surge worked,' or 'we are winning.' I've even heard 'we've won.'

I thought of such official-speak upon reading this article in the London Review of Books, written by Patrick Cockburn. It is titled 'America Concedes.' From reading it I learned that,

On 27 November the Iraqi parliament voted by a large majority in favour of a security agreement with the US under which its 150,000 troops will withdraw from Iraqi cities, towns and villages by 30 June next year and from all of Iraq by 31 December 2011. The Iraqi government will take over military responsibility for the Green Zone in Baghdad, the heart of American power in Iraq, in a few weeks’ time. Private security companies will lose legal immunity. US military operations will only be carried out with Iraqi consent. No US military bases will remain after the last American troops leave in 2011 and in the interim the US military is banned from carrying out attacks on other countries from within Iraq.

The Status of Forces Agreement (SOFA), signed after eight months of rancorous negotiations, is categorical and unconditional. America’s bid to act as the world’s only super-power and to establish quasi-colonial control of Iraq, an attempt that began with the invasion of 2003, has ended in failure. There will be a national referendum on the new agreement next July, but the accord is to be implemented immediately, so the poll will be largely irrelevant. Even Iran, which had denounced the first drafts of the SOFA, fearing that any agreement would enshrine a permanent US presence in Iraq, now says that it will officially back the new security pact after the referendum: a sure sign that America’s main rival in the Middle East sees the accord as marking the end of the occupation and the end of any notion of Iraq being used as a launching-pad for military assaults on its neighbours.

Astonishingly, this momentous agreement was greeted with little surprise or interest outside Iraq. On the day that it was finally passed by the Iraqi parliament international attention was focused on the terrorist attacks in Mumbai. For some months polls in the US have shown that the economic crisis has replaced the Iraqi war in the minds of American voters. In any case, Bush has declared so many spurious milestones to have been passed in Iraq over the years that when a real turning point is reached people are naturally sceptical about its significance. The White House is anyway so keen to keep quiet about what it has agreed in Iraq that it hasn’t even published a copy of the SOFA in English. Some senior officials in the Pentagon privately criticise Bush for conceding so much, but the American media are fixated on the incoming Obama administration and no longer pay much attention to the doings of Bush and Co.

. . . .

The Iraqi government will become stronger as the Americans begin to depart. It will also be forced to take full responsibility for the failings of the Iraqi state. This comes at a bad moment for the government because the price of oil, the state’s only source of revenue, has fallen to $50 a barrel, when the budget assumed it would be $80. Many state salaries – those of teachers, for example – were doubled on the strength of this estimate. Communal differences are still largely unresolved. Although friction between Sunni and Shia, bad though it is, is less than it was two years ago, hostility between Arabs and Kurds is deepening. The departure of the US military frightens many Sunni, who will be at the mercy of the majority Shia. But it is also an incentive for the three main communities to come to an agreement about their relations with one another: there will soon be no Americans left to stand between them. America’s troops will depart, leaving behind a ruined country.

The thesis of the article seems to be this: Any bogus official-speak notwithstanding, America has in reality lost the Iraq War.

Creating a basis for credible economic growth

For some time now, I have been constructing a two-part (hypo)thesis about the future of the US economy. I am still putting together the pieces, and learning as much as I can, but here it is: About a year and a half ago, after three years of significant study, I began to say out loud to people willing to hear things like this, that within the next five to ten years the dollar would face a day of significant reckoning. I began to believe this because the massive growth of GDP and expansion of the money supply the past three decades have been, as I began to see it, the result of illegitimate and unsustainable systemic actions by the country's elite economic actors. In short, we have borrowed too much relative to how much we have produced. So our economic growth has lacked credibility: the reality does not match the myths we have told ourselves, namely, that our 'fundamentals were sound.'. As soon as, my hypothesis went, the relevant participants in the world economy recognized this -- say, the American government, the Chinese government, American investors, foreign investors -- major change would then be upon us in terms of the dollar and Americans' purchasing power.

Let me explain some of the details, as I see them. Our growth the past three decades has been disproportionately greater than the production of valuable goods, services, or knowledge that should be its basis. And our money-supply expansion has not been the result of greater gold reserves. Rather, it is the result of international political power, the 'right' to disproportionately shape the world's exchange rates, and massively unbalancec capital flows toward US bond markets. In short, we've been living on credit because the rest of the world -- especially China -- have been financing and re-financing our debt.

As such, our growth and monetary actions have been the result of a massive credit-grab unprecedented in the history of mankind.

This is why the relationship between the US and China strikes me as so important, and why I so often write about it in this space. China is the reason we've been able to engage in this credit-grab. Without China we likely wouldn't have been able to so immensely leverage our capital and expand our bottom lines. Therefore, if the relationship between the US and China changes, or is changing, and I think it is, this is a major event. The reason: China's willingness to grow its surplus, constrain its population's standard of living, and finance the US dollar through long-term treasury purchases is the single biggest basis of American growth during this era. As soon as China changes these actions, the American economy will return to a level of wealth more proportionate to the value we add to the world economy through our production of goods, services, and knowledge. We will still be wealthy, but not nearly like we've experienced the past decade. My sense is that America is slowly returning to a more production-based economy, while China will become more consumption-oriented.

This will put the world's economy in a better balance, and America's economic growth -- once we can get it started again -- will be more legitimate, sustainable, and equally distributed within our population. That is, our growth will again be credible. But our standard of living will recede for the next decade or two. How much it will recece, I don't know. We'll have to wait and see.

As a result of all this, the most important thing we can do is recognize that credibility is a multilateral construct. Credibility exists in the eye of the beholder. We cannot force other people around the world to interpret the US economy as legitimate. We cannot force them to behave in a certain way. We can't forever expect the rest of the world to interpret their own economic interests as financing ours. Especially if we continue to act irresponsibly with bad loans and even worse wars. We must create an economy that, once again, inspires confidence in the minds of others. Only after we have created this credibility, will our standard of living begin to return levels we've grown accustomed to.

To this end, we should immediately begin to build the social insitutions it will take to create the goods, services, and knowledge that the whole world craves, and that the US is in the best position to produce. Less finance, more practical creativity.

Nouriel Roubini estimates a total of $3.6 trillion in loan losses

How much of this -3.6 is still to come?

I susbscribe to REG Monitor, economist Nouriel Roubini's global economics newsletter. I just got the following in my inbox, an update on just how many billions/trillions of dollars the US is facing in losses due to the bad loans still clogging up our banks' balance sheets. Of the $3.6 trillion he ultimately sees being written down, he estimates the US is directly exposed to about half -- $1.8 trillion. The key question, then, is: How much of this $1.8 trillion have we already written down? Are we most of the way through? Half-way through? Have we barely begun?

Anyway, here's the email:

RGE Monitor Estimates $3.6 Trillion Loan and Securities Losses in the U.S. Nouriel Roubini and Elisa Parisi-Capone of RGE Monitor release new estimates for expected loan losses and writedowns on U.S. originated securitizations:

--Loan losses on a total of $12.37 trillion unsecuritized loans are expected to reach $1.6 trillion. Of these, U.S. banks and brokers are expected to incur $1.1 trillion.

--Mark-to-market writedowns based on derivatives prices and cash bond indices on a further $10.84 trillion in securities reached about $2 trillion ($1.92 trillion.) About 40% of these securities (and losses) are held abroad according to flow-of-funds data. U.S. banks and broker dealers are assumed to incur a share of 30-35%, or $600-700 billion in securities writedowns.

--Total loan losses and securities writedowns on U.S. originated assets are expected to reach about $3.6 trillion. The U.S. banking sector is exposed to half of this figure, or $1.8 trillion (i.e. $1.1 trillion loan losses + $700bn writedowns.)

--FDIC-insured banks’ capitalization is $1.3 trillion as of Q3 2008; investment banks had $110bn in equity capital as of Q3 2008. Past recapitalization via TARP 1 funds of $230bn and private capital of $200bn still leaves the U.S. banking system borderline insolvent if our loss estimates materialize.

--In order to restore safe lending, additional private and/or public capital in the order of $1 – 1.4 trillion is needed. This magnitude calls for a comprehensive solution along the lines of a ‘bad bank’ as proposed by policy makers or an outright restructuring through a new RTC.

--Back in September, Nouriel Roubini proposed a solution for the banking crisis that also addresses the root causes of the financial turmoil in the housing and the household sectors. The HOME (Home Owners’ Mortgage Enterprise) program combines a RTC to deal with toxic assets, a HOLC to reduce homeowers’ debt, and a RFC to recapitalize viable banks.

Hedge funds, networks, and economic sociology

One of the seminal assumptions of economic sociology is that markets are best conceptualized not as a sum of atomized individuals chasing their own self-developed interests, but as a product of relationships and interactions between individuals within a social environment. This environment is characterized by cultural norms, social change, political power, and trust. In short, markets are a field of networks wherein some people know the right people, some people don't know the right people, some people are in the right place at the right time, some people aren't, etc. Individuals, as such, are not uniformly rational 'agents' but, rather, are shaped in infinite ways by their environment and the interactions that take place within it. Finally, while it's not yet a central part of economic sociology, I would add to this that all these relationships take place within a context of massive organizational structures (e.g., corporations).

This article by Donald MacKenzie, a sociologist at the University of Edinburgh, provides a powerful example of markets as networks using the 'hedge fund' as a case illustration. Here's a particularly relevant excerpt. The main point comes in the second and third paragraphs. The first paragraph is a short description of the significance of hedge funds in the economic process:

[Hedge funds] control substantial amounts of capital. If a hedge fund manages less than $100 million it’s not seen as a big player; $1 billion or so is reasonably commonplace. The capital managed by the world’s ten thousand or so hedge funds totals around $2,000 billion. (Hedge funds don’t have to divulge the details of their finances and operations, so no-one knows the exact numbers.) About a fifth of this money is managed by funds based in London, and two fifths by those based in the US, mostly in New York and its upmarket suburbs, especially Greenwich, Connecticut.

. . . .

How do you get to run a hedge fund? Nearly all of those I’ve met who do this made their names as traders or managers in the big investment banks. Some simply want to make more money, but often the motivations are more complex. A couple of years ago, one professional investor in hedge funds told me that ‘a lot of the people who are setting up the best hedge funds are ... doing this for perhaps slightly egodriven and political reasons as much as anything else. They’re not doing it for the money: they’ve got their Bentley Continentals and their yachts ... so they’re going into it because they want to run something because they’re never, ever going to be the guy that sits right at the top [of an investment bank] because they can’t be bothered with the politics [i.e. organisational conflicts and jostling for promotion].’

Their previous careers in banks are often crucial to those trying to set up hedge funds. The accumulated bonuses they’ve received give them their initial stake, and they’ve built networks of contacts. Financial markets aren’t the atomistic, anonymous places portrayed in conventional economic models. Asked how he set up his fund, one manager told me: ‘you call your friends and, you know, just talk through your ideas’. If they are persuaded by the latter, those contacts may decide themselves to invest in the fund (if they have been successful, they too are likely to have substantial assets), and they also pass you on to other potential investors: ‘eventually you kind of pitch to people who allocate capital and if they like the idea they put money in; if they don’t then they send you on your way’. These investors will want to assess the personal characteristics of those pitching to them: asked how he actually knew what proportion of managers’ personal wealth was invested in their funds, one investor told me ‘it’s a look-in-the-eye part of it’. Professional allocators of capital will often phone people they trust who have worked with the aspirant founders of hedge funds. You’ll get phoned up, said a well-established hedge fund manager, and asked ‘“do you know so-and so?” And if you say, “oh actually he’s a smart guy”, that’s good; if you say “I’d rather not comment” ... That’s one of the ways it works, and because it’s people ... coming from those five or six big companies [the leading investment banks] the funds of funds have a fairly easy job of checking up’.

Disappearing wealth and the problem of knowledge

America, and Americans, have for a while now considered a part of settled 'knowledge' a lot of things we can't anymore claim as real knowledge. For example, the sacred free-market: as a consensus grows around the notion of government intervention to save capitalism, the old belief that the market stands best when standing alone is quickly becoming outdated. As a result, we are collectively experiencing what the philosopher John Dewey called a 'problematic situation' -- when old habits aren't up to the task of reasonably interpreting present reality, an individual or a country faces a problem. What should we now think? And how do we have to adapt our behavior to face the new facts? As I see present events unfolding, the most tangible problem about our old knowledge is this: We aren't as wealthy as we thought we were. I'll get back to this point in lots of future posts, but today I want to discuss the two data-images just below, which both deal with the task before us: gaining a grasp of reality independent of our old habits and beliefs. This takes, of course, data.

Is there a credit crisis? Paul Krugman says yes, Dean Baker says . . .

. . . not really.

The second (bottom) data-image is Mr. Krugman's. It shows a spike in borrowing rates for AAA and Baa grade relative to 30-year Treasuries. Mr. Krugman concludes, "So yes, we do have a credit crunch. It’s not the whole story, but it’s part of the story."

The first (top) data-image is Mr. Baker's, via the NY Times. Mr. Baker points out that while corporate debt issuance dipped dramatically in 3Q of 2008, 4Q saw a return to levels of borrowing similar to preceding months and years. Mr Baker concludes, "the economy is not in a downturn because banks aren't lending. It is in a downturn because we have just lost $6 trillion in housing wealth and $8 trillion in stock wealth. The expected effects of this loss of wealth is the huge falloff in consumption that is driving the downturn. The condition of the banks is very much a secondary issue."

The debate between these two, as I read it, centers then on whether the 'credit crunch' is helping drive the loss of our nation's wealth, or if the 'credit crunch' is a residual effect of the downturn in housing and stocks.

My question to them would center around the loss of wealth in terms of credit. Specifically, is the act of 'de-leveraging' -- which as I understand it is the systematic adjustment of credit-capital ratios back to historically normal ratios -- deemed part of the 'credit crisis' or not? To me, de-leveraging's a primary story. And it has to do with both (a) a deteriorating credit environment, in which the collective debt of US organizations isn't worth what we got used to it being worth, and therefore we can't say as easily, lend me more money; and (b) the drop in the stock prices of companies, who all of a sudden aren't as capitalized, again, as we thought.

Indeed, a lot of things we thought we knew are disappearing into thin air.

What to do with the country's bad assets?

As we all know, we inhabitors of the world economy -- specifically, western banks, more specifically, American banks -- have a whole bunch of bad assets on our balance sheet. These bad assets are loans that aren't bringing in liquidity on any private market, any time soon. The original bailout plan was for the US government to buy this debt -- to, in effect, create a market (or, a price mechanism) for these bad loans. This was TARP. But then, Sec. Paulson switched gears, and instead of buying the debt, he decided -- following Europe -- to simply inject capital directly into troubled banks, leaving the bad assets on their sheets.

Recently, the idea of the government buying the loans has resurfaced. But the same central problem remains: At what price and according to what motivation? If the government pays the banks what would amount to market values, the banks will receive very little actual help. If on the other hand the government buys the debt at values that return the banks to viable operations, tax-payers will have gotten screwed. This is because tax-payers will not get a return on the assets at the value it would take to return the banks to solvency.

So, what to do?

Again, we are debating government action because there is no private market for the debt. Nobody wants to touch it. Nobody wants to touch any organization or borrower who even whiffs of being close to the debt, hence the so-called credit crisis. Quite a problem we've got. I look forward to seeing what 2009 brings.

My sense is the following. I see 'motivation' as determinative in this instance. Are we motivated by 'free-market' ideology whereby it is wrong for governments to assist banks irrespective of the consequences? Or are we motivated by the consequences? President Obama clearly has his mind tuned to the latter. But there are still Republican congressmen not to mention many Americans who think ideologically, that is, in terms of a socialism-capitalism, bad-good dualism that to me is increasingly outdated.

Once we settle what our motivations are -- if we haven't already, we are close to this point -- we turn to step two: technical execution. I'll say more about that soon.