Is the dollar sacred?

With all the money being printed by the government, and the fact that the dollar's foreign financiers appear -- appear -- to be losing at least some interest in maintaining their dollar investments, and the fact that America's debt is over $10 trillion (10 TRILLION!), and every year we keep growing deficits, and America's leaders on Wall Street and in Washington (including Barack Obama) seem to be more interested in re-inflating the economy in the short term in terms of bubbles rather than doing the hard work to increase the real-world productivity of our economy -- all this continues to lead me to think there's a chance for massive currency change both in the world and in the US. A chance for massive change along the lines of the end of the dollar-dominated world, and maybe just maybe the end of the dollar itself.

How would people respond to an event like this? For example, would the disappearance of the dollar be seen by Americans as an affront to their traditional way of life? Would we cling to the dollar for cultural reasons well past the time the dollar is in our economic interests? Will the dollar come to symbolically represent 'the American way of life that we must preserve'? At its moment of truth, will there be something particularly sacred about the way Americans think about the dollar that could preserve it? Or will we say, fine, let's move on?

Today's Financial Times: Brazil and China re-thinking their dollar strategies

From today's FT:

Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil's central bank and aides to Luiz Inácio Lula da Silva, Brazil's president. The move follows recent Chinese challenges to the status of the dollar as the world's leading international currency.

Read the online article here, or click on the picture.

Nouriel Roubini on the future of money

Nouriel Roubini, in today's New York Times:

The 19th century was dominated by the British Empire, the 20th century by the United States. We may now be entering the Asian century, dominated by a rising China and its currency. While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear.

Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined — and the pound lost its status as the main global reserve currency — when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time.

. . . .

The quality of money

I hear people around me worrying about the quantity of money the government is printing. I not only hear the talk, I worry about it too. But the real question is about the quality of that money. Are we printing credible dollars? Will people, organizations, nations still want to invest in our money? That is to say, will the people who have financed our economy the past few decades want to continue to do so? Do they perceive the dollar as a quality, credible investment?

If people around the world and in our country, poor and rich alike, continue to see (or begin to see again) the dollar as a credible currency to earn and invest in, and thereby enrich who ever holds it, then our government can print all the money it wants. We can print money, in other words, unless and until there's no one who wants it. The social demand for money is a significant, necessary basis of money.

One problem: The quality of American money has for a really long time been assumed by those who study it to be credible. As a result, right now, compared to the number of social scientists who study the quantity of money, which is many, there are incredibly few who study the quality of it: whether or not American money is credible just hasn't been a burning question.

Until now. I suspect things will now begin to change. Qualitative approaches to all things economic -- like money and marketing -- should begin to take off, as a result of current events (meaning the financial collapse and the question of America's economic credibility and how to re-store it). The interesting questions are how swiftly the intellectual adaptation will take place, who will drive it and benefit, and how.

National credit-worthiness

Data-images from Krishna Guha's report in yesterday's FT Times.

I hear it said sometimes that national boundaries mean less today than they used to. The word 'globalization' is thrown around. We have come to the end of 'national soveriegnty.' Nations now are all 'in it together.' 'Interdependent.'

I don't doubt the people who say these things are right, and that globalization is significant. But we all still live in nations, whether we like it or not.

In fact, I think Americans are right now facing a major problem that sits squarely at the feet of us as a nation: As a people our collective debt/wealth, taken together, is worth far, far less than it was sitting at 21 months ago (see the middle data-image above). Some of us are doing fine anyway. Some of us aren't. There are major differences among us. But together, no matter where you are, your life is affected by the dramatic depression in the value of American debt. Financing like we've enjoyed the past decade just isn't available right now, and companies as well as households are forced to cut back in this world without such easy money.

Have you heard the phrase 'toxic assets'? That our banks hold toxic assets is the crux of the current financial crisis. So what is a toxic asset? Toxic assets mean debt nobody will purchase.

I have to say, I find that so remarkable, that our debt is near worthless. The most followed economist of the last fifty years -- Milton Friedman -- figured he'd never see the day the collective debt of private Americans couldn't find a market. And here we are, living through precisely that, getting to look at it with our own eyes. But Mr. Friedman was right: he didn't live to see it. He passed on in 2006, bless his soul, a full year ahead of the meltdown that began in August 2007.

So, anyway, I assume economic growth is the goal. How then do we achieve it? The situation we have is the following, and it's not pretty. Either we quickly re-store our national credit-worthiness to past levels and beyond, trying to maintain the system we have enjoyed so much in which the world stockpiles dollars and finances American debt. Or we use political power to create a new system that is, like the previous one, built toward our interests.

Put another way, the question is, have we hit the peak of diminishing returns of the old system? Should we scrap it? Oh, but then we can't forget: Are we intellectually smart enough to create a robust and prosperous new system? And I guess we even need to ask: Are we that politically powerful any longer? After Iraq, and with the rise of China, ignoring this question seems untenable.

It might just be me, but it seems to be the case that, for the first time since WWII, economic growth in America has a highly uncertain future. If so, that means, cautiously speaking, that we are entering an entirely new kind of America from that which anybody under the age of 60 has ever experienced.

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.

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.

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.

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.

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.

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.

US-China: The Shift

Earlier -- I guess yesterday, by now -- I cited evidence that has come out lately suggesting the possibility of a shift in the China-US economic relationship. Specifically, it is possible that China is in the process of slowing down or maybe even contracting its purchases of US treasuries and dollars. Let me be clear, there is evidence of a shift, not proof. But I think it is best if we start analyzing reality as if the shift is here. So we can start planning. In that vein, very few of us can claim to know what the shift means, or would mean. Questions like whether it'll be 'good' for the US, terrible for the US, or perhaps if it'll be boring and non-descript -- these are just about unanswerable except in speculative terms. My sense tells me the shift will mean that America needs nothing less than a new basis of economic growth; that is, if the age of foreign financing is slowly coming to an end. China's move away from the dollar and away from the financing of US debt -- whether already underway, or on the horizon -- is exciting, scary, puzzling, challenging. And probably many other things. It is coming upon us faster than otherwise because of the credit crisis. But really, we should be able to see that the shift was (or is) basically inevitable: China wasn't (isn't) going to finance our lifestyle forever, right? Here's to hoping our leaders had (have) a backup plan, just in case. Because 'in case' just might be what we now have.

Over-leveraged

If you want to read an early forewarning about the collapse of Wall Street and the economic troubles we all now feel and see, try this by Nouriel Roubini. It is his written testimony to Congress way back in February of 2008, before the first bank implosion (Bear Stearns). It is a bit out-dated now, referring to oil in the $100s. But this guy had a good sense of what was to come before it came. Had his knowledge been a greater part of recognized knowledge, our country could have begun a process of planning for the current mess. Instead, we were behind the curve.

A hypothesis of mine is this: American leadership over the past 20+ years has not done a good job analyzing and preparing for a wide-range of possible consequences -- specifically, unintended consequences -- that would result from their actions. The government actions that define the current era -- like expanding the money supply, cutting interest rates, depreciating the dollar, deregulating markets, undermining the tenability of unions, and financing our debt by integrating our economy with China and others -- have led to incredible growth, as they were intended to do. But have these actions created a basis of growth that was sustainable? Events seem to suggest no. And instead of admitting that and preparing a Plan B for the inevitable time when plan A hit the end of its road, have we now come to a point we must adapt to a world not of our own making and not in our interests?

The question is, how prepared are we for this moment when America must 'de-leverage.' De-leveraging means, in a nutshell, returning our debt-income ratios back to sustainable levels. For the past three decades, we -- the country, families, organizations -- have steadily increased the level at which our operations are paid for with credit. For a significant part of the country, and collectively as a country, this credit is no longer there. De-leveraging means we are going to find out we are not as rich today as we thought we were yesterday. The current economic downturn is different than a normal recession in the sense that the contraction itself is not the main story. The main story is the possibility that we may be upon a structural adjustment of the economy away from credit to some other basis of growth.

In the 1970s the great sociologist Daniel Bell predicted economic growth would increasingly come from knowledge. He was right, in a sense. It takes a whole lot of knowledge to create and package debt into forms that look like wealth. But the story of our economic growth the past few decades is the debt, or credit, not the knowledge. In fact, one of the untold consequences of the Wall Street collapse is the speed at which a whole lot of financial knowledge went poof, disappearing into thin air.

But maybe Prof. Bell's vision of a country of theoretical knowledge workers spending their 9-5s hard at work creating socially useful products will still come true. Maybe that's what this 'green economy' is all about.

The incredible, growing supply of money

What does the future have in store?

In their effort to stem the tide of the current economic/financial crisis, have the economic decision-makers of the US government stepped over a line? Since August, the US government has increased the monetary base -- the most liquid measure of the money supply -- by seventy percent. Seventy percent! There are that many more dollars today than there were three months ago.

Why is this happening? It seems the government's working plan is to increase the money supply and inflate the dollar so that the nation's incredible debt -- $10 trillion -- is more manageable. Fair enough. But what will be the unintended consequences of such action? Will the dollar be able to withstand the pressure of such over-supply? More to the point: With such loose monetary conditions, how much longer will the dollar exist in the form that we now know it?

Imagining a world in which the dollar has been replaced with something else sounds far-fetched. But the current crisis, in combination with our immense debt, in combination with what our economists are doing to combat the crisis and the debt, just might be the string of actions/events that make a dramatic change to American currency possible. Perhaps even likely.

'Be nice to the countries that lend you money'

China's leading investment official, Gao Xiqing, suggests we Americans take such advice to heart. Read an interview between Mr. Xiqing and one of America's leading journalists, James Fallows, here.

An excerpt:

Mr. Fallows: With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?

Mr. Xiqing: Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. [This is the famous modern “balance of financial terror.” If Chinese officials started pulling assets out of the U.S. and touched off a run on the dollar, their vast remaining dollar holdings would plummet in value.] So we’re trying to help, at least by not aggravating the problem.

But I think at the end of the day, the American government needs to talk with people and say: “Why don’t we get together and think about this? If China has $2 trillion, Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone.” We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.

Kenneth Rogoff makes the case for more inflation . . .

I don't buy it

Prof. Rogoff is a highly respected Harvard economist. In this article, he argues that deliberate inflation policies should be considered to fight the housing downturn. Here's a bit of what he says:

In addition to tempering debt problems, a short burst of moderate inflation would reduce the real (inflation-adjusted) value of residential real estate, making it easier for that market to stabilise. Absent significant inflation, nominal house prices probably need to fall another 15% in the US, and more in Spain, the UK and many other countries. If inflation rises, nominal house prices don't need to fall as much.

Of course, given the ongoing recession, it may not be so easy for central banks to achieve any inflation at all right now. Indeed, it seems like avoiding sustained deflation, or falling prices, is all they can manage.

Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20% or 30% instead of 5-6%. Indeed, fear of overshooting paralysed the Bank of Japan for a decade. But this problem is easily negotiated. With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.

It will take every tool in the box to fix today's once-in-a-century financial crisis. Fear of inflation, when viewed in the context of a possible global depression, is like worrying about getting the measles when one is in danger of getting the plague.

I understand his point. And Prof. Rogoff has forgotten more than I know about economics. But I find his prescription absurd. Why are economists bending over backwards to manipulate markets into behaving the way we think we want them to? The fact is, and nobody disputes this, housing prices rose due to a severe, artifical propping up of available credit. The bubble has now popped and Americans, and America, are now finding out we aren't as rich as we thought we were.

It is best if we let this market correction occur, and instead of inflating our way out of the problem, it is best if we do the long, hard work of creating sustainable forms of new wealth. To do this, we will need steady, productive employment for America's families and individuals. We are going to get out of this problem with neither easy credit nor inflation. Rather, we need to create wealth-producing jobs and incomes. I am thinking in terms of a $600 billion - $1 trillion demand-side economic stimulus. I hope it goes into effect as soon as President Obama takes office.

Is it time to invest in US stocks?

Source: FT.com.

Martin Wolf is an economic writer for the Financial Times. He is widely respected. He was also many months ago presciently quoting Nouriel Roubini -- the economist who predicted our current mess before just about anyone else -- when everyone else thought he was crazy. Well, Mr. Wolf seems to be suggesting it is time to buy US stocks. In today's FT, Mr. Wolf writes the following:

[I]nvestors with long time horizons (the relatively young, or institutions) are, for the first time in almost two decades, confronting attractive, although not sensationally attractive, market valuations.

Mr. Wolf hedges himself a bit:

[T]here are, nevertheless, formidable pressures for further falls in valuations, as leveraged players continue to be forced to offload assets at bargain prices.

Read the whole article here.

My own view is that the bottom in the Dow we recently experienced (about 7,800) will be broken. Simply put, there is too much bad news on the horizon for the lows not to be re-set. Unemployment, earnings, and growth numbers in the macroeconomy are going to be giving us bad numbers the next six or twelve months. I think the bottom will be around February, or March, or even later. Remember, GDP numbers for 4Q 2008 are going to be horrendous as consumers are pulling back and jobs are being lost.

I see good times ahead for investors, but only when the economy actually has the workers and the consumers that it takes to sustain strong earnings.

By that I mean, some demand-side stimulus.

Tax cuts

The big debate going on around President Obama's economic plan is not his seeming idea for a $600 billion demand-side stimulus. Surprisngly, at least to me, everyone seems to grant this idea. Rather, the conflictual question is about his tax plan -- is he going to repeal the Bush tax cuts for the investing class? The corporate tax rate, the top income tax rate, and the capital gains tax rate -- is he going to raise these? The investors want him to hold on to the current rates. But President Obama has hinted (actually he has more than hinted) that he will raise the top tax rates to the pre-Bush, that is, to the Clinton-era rates.

I love the fact that, as of right now, President Obama hasn't given in. According to his press conference today, President Obama still holds to the idea that the thing to do is pay for his stimulus plan with slightly higher tax rates for the investing class.

The reason I support raising the top tax rate -- and even raising the capital gains rate a few percentages -- is that the let-the-investors-build-our-economy argument has been proven to be hollow, at least for the moment. This argument is that President Obama's tax plan will cut out the investment class from its knees and bring wealth-creation to zero. To raise investors' taxes is to discourage them from investing in ways that would help us all.

This argument, however, holds little sway in a moment in which the investing class -- you know: companies like Citigroup, Goldman Sachs, JP Morgan, etc -- are pleading with the government to bail them out with more and more bailout money. In fact, it is because of the investing class, more than any other category of actors, that we have an economic crisis today that is threatening to challenge the Great Depression in social impact.

I say, pay for a demand-side stimulus with tax revenue taken from the supply-side. A few years from now, when the economy has stabilized -- and I think it will stabilize in a few years -- begin again to lower the supplier's tax rates, but with BUT WITH new regulations directly learned from the great financial collapse of 2008 so as to prevent another one.

In sum, I would support President Obama if he immediately repealed the Bush tax cuts for the investing class. I am a big supporter of the investing class. But we cannot reward them at a moment that they have put our country in such a crisis. Once they clean their house, a few years from now, then let's hope President Obama throws them a tax cut.

Citigroup in talks with the American government

Here's the NY Times story.

As part of the $700 billion Bailout, Citigroup received $25 billion in October. This money was direct re-capitalization of the sort that Sec. Paulson said he wouldn't do and then did. Does the fact they are in talks with the government mean that Citigroup is going to need more money? Is giving them more money a good idea? For who is actually more systemically important, Citigroup (who already got their $25 billion but look like they need more)? Or GM, who are right now effectively being denied their $25 billion? Which company affects more jobs, directly and indirectly?

Certainly, Citigroup affects the credit markets -- but Americans' (and America's) credit is being severely diminished as it is. Saving Citigroup won't exactly fix that situation. Though perhaps it will keep it from getting worse.

But shouldn't the focus be on making things good again, rather than simply keeping things from being really, really bad? Isn't letting things go from bad to worse acceptable if it is part of a smart plan to turn things around toward the good? If the tight purse that is being drudged up in the case of GM and Detroit is a case of a nation having to make hard choices about which companies to support and which to let whither away, how do we know we are making the right choices?

So far, the debate that is actually happening strikes me as being defined by ideology and personal interest more than by data and pragmatic decision-making. After years of incredible fiscal irresponsibility when they are in power, the Republicans are -- surprise -- returning to a mantra of no more spending when they aren't in power. And the Democrats continue to be hamstrung by associations with auto unions, whose own special interests drive Democratic support for some kind of a Detroit bailout. Perhaps a bailout is a good idea, but support for unions and their bloated contracts is not a good reason for it.

That said, America needs to create more jobs for its people. If we were to enact policies to initiate a better labor market, and were we to return to upwardly moving wages, credit and consumer problems could be relieved and Americans could save more.

My cautiously hard-core stance is this: Let troubled companies go bankrupt. Quit wasting money on organizations that have failed, including the car companies. And then as soon as January rolls around, put forth a $600 billion stimulus package aimed at creating jobs in the short-, medium-, and long-terms. This should include enhanced unemployment insurance, as well as money for re-training the former auto factory workers.

Obama picks NY Fed Chief Tim Geithner as Treasury Secretary

Don't ask me if he's a good pick.

The only thing clear to me are the key questions. For we have a better idea, due to the struggles that current Treasury Secretary Henry Paulson has gone through, about what will determine whether Mr. Geithner is successful and ultimately seen as a good pick.

The questions revolve around public relations. Nobody doubts Mr. Geithner has expert knowledge. Or whether President Obama's economic team will be the best economists around. They certainly will be, which is a major difference between President Obama and his predecessor, whose calculations were always done with political rather than knowledge concerns at heart.

The key questions are, will Mr. Geithner prove to inspire confidence? Will he be an effective communicator? Will he give off the feeling he is confident and adapting to new conditions in a rational, data-driven, expert fashion? Will he relate well to people who aren't themselves experts? In short, it comes down to legitimacy. Will he prove worthy of being granted legitimacy by the American public?

It is on these questions that Sec. Paulson has failed miserably.