Happy New Year

Many people around the globe celebrated Christmas on Saturday and whether or not you are a Christian Christmas it is a big day for most of us. Those who like to shop love the opportunities December affords. Those who cherish the spiritual part and the giving can feel and share their love of God and their fellow man with great intensity. Those who enjoy parties will get plenty of time to revel and gain weight which they can dutifully plan to shed in the New Year. The rest of you will hopefully enjoy the beauty of winter and the anticipation about what 2011 will bring. Those of you on the East Coast may have enjoyed enough winter!

I am pleased to give you all a really big gift by taking this week off from venting my spleen in my blog. But I do want to thank-you for giving me the chance to spout off in 2010. As you know I retired from Indiana University last January and I was not very sure how the first year would go. As it turned out I got chances to teach for a couple of months in South Korea and Vietnam. Last January I was lucky to share some ideas about macro on a nice little island off the coast of Florida. These teaching experiences kept me connected to macro and teaching. But the blog was my constant companion over this year and it gave me impetus each week to keep up with the latest news and issues. As you know it was a year in which macro could have won an Emmy Award.  There was never a time when I sat at my computer wondering if there was something juicy to write about.

Writing helps me to think in a more organized way. It also helps me get things off my chest. I always feel a lot better when I post a message. I admit that it is a very selfish affair for me. I can only hope that you benefit from my macro-thoughts. For all that I leave you with my thanks and a brief personal message.

My family and especially my parents and spouse always saw and see the world through an optimistic prism. To them, the world’s glass (of JD) is always half full. They never met an enemy and usually interpret difference of opinion and argument as a result of the complexity and changing nature of most phenomena. We might think of an adversary as misguided or misinformed but mostly we believe the interactions with them make us better informed about our own judgments. How boring and cruel a world would be if we all shared the same opinions about everything!

No matter what I might say about an issue or a person or a political party I hope it is taken in this positive spirit. I will do my best in 2011 to respect those who hold different opinions but I hope I never shy away from what I consider to be the right and the wrong of a particular issue or policy. We humans have much more that binds us than divides us and I hope we realize that as we move into an exciting but potentially divisive year.

You might be curious who reads my blog. It is mostly insane people I know pretty well. They include my former students, my recent students in Seoul, Hanoi, and Sanibel Island, and many colleagues. But I also badger various relatives, friends, and neighbors who might have some interest in macro.  I connect with all these people through Google’s Blogspot, Facebook, Linked-In, and Twitter. I also send a personal email to 100 and something people.

Blogspot has a statistics option which lets me know information about those who read my posts. Here are a few facts:

• ·         Since June of 2010 I posted 64 articles on 21 different macro topics (you can see all the topics on the lower right corner of the home page if you scroll down)
• ·         I posted 11 articles on Macro Policy, 8 on Exchange Rates and Policy, 6 on Employment and Unemployment, and so on.
• ·         The most popular articles were Fairy Tales Can Come True (Aug 6), AT&T (July 4), the Myopic Squirrel (Sept 13), The G20 (Oct 28), and Lilliputians(Aug 23).
• ·         There have been approximately 4,000 pageviews – posts that have been read or at least opened
• ·         While 75%of these page views came from the USA, I seem to have readers in South Korea, the UK, Vietnam, Canada, India, China, Germany, Spain, France and Finland.
• ·         Almost half of you used IE to connect but 24% used Firefox and another 25% used either Chrome or Safari.

I look forward to more spouting in 2011! Best to you all.

Nobel Nonsense and President Obama

I was going to take the week off and send you a nice holiday message and then one of my colleagues sent me the link to a Paul Krugman article. I guess I will send you my holiday message later in the week. 

I don’t like to read Paul Krugman articles because it is bad for my blood pressure. This guy has a Nobel Prize in economics which makes you think he might really care about his science but instead he uses his elite position to be the spokes person for one extreme view of economics. With his behavior he gives a bad name to the science and it riles me a bit. I would think that even liberals would be embarrassed by some of his antics.

In “When Zombies Win” http://www.nytimes.com/2010/12/20/opinion/20krugman.html , Krugman uses colorful language to say basically two things. First, Obamanomics didn’t fail – the President simply didn’t try enough economic stimuli. He had the right idea -- he simply didn't do enough of it. Second, he says President Obama, unlike Reagan who stuck with his ideas, has been cast into a spell by conservative zombies and they are going to eat his brain and our economy with it. Really – this Nobel Award winner said that!

To prove that Obama’s stimulus package was too small, he says “government spending on goods and services grew more slowly than during the Bush years, hardly constitutes a test of Keynesian economics.” Wow – talk about a real economic scientist! He uses government spending on goods and services as the only real data pertinent to stimulus in the last two years. Dear Paul – what about government transfer spending? What about government bailouts? What about tax cuts? Does anyone really think he provides a full coffin of evidence about stimulus by measuring only GPGS? I am glad for any college student taking freshmen economics who would not give such an answer on his or her final exam.

Then Krugman says that conservatives are totally discredited because inflation and interest rates have not risen in response to the stimuli. I am guessing that few economists really predicted a rise in inflation BEFORE the economy started to recover in earnest.  Most of us believe that something called the GDP Gap needs to closed before inflation starts rising. We also would not see interest rates rising until the paranoia about slow growth significantly reduced the demand for government bonds. Krugman turned a very legitimate worry or concern about stimulus causing higher inflation and interest rates into a forecast – and one that all his adversaries must have agreed with.  Talk about creating a straw man!  He also says that disinflation continues. Technically, that means that the inflation rate continues to fall.  Does he provide a shred of data or evidence? How much did the inflation rate fall in the last, say six months? Three months?

That Obama had the audacity to praise Ronald Reagan and admitted that some austerity is necessary for historically high levels of deficits and debt, make the President Zombie prey.  Those nasty Republicans made him say “Uncle” and now, according to Krugman, he can never oppose their incessant demands for ghoulish austere economics.

Krugman cites Ireland as an example of why austerity policy is bad. I guess that is the sum total of his knowledge about austerity and the experiences of no other countries matter. I would hope that no freshman university student would write such flimsy answers to important questions. Of course, if you happen to be Irish then you might want to reserve judgment about what did or didn’t help the Irish find their way out of their very tough present economic condition.  

Like Krugman, I don’t like the way Obama supported a tax plan that goes in the wrong direction. As I wrote last week, this won’t create enough stimuli to reduce the rate of unemployment. But Krugman wants more stimuli and that’s where he and I part ways. The US economy is gagging on past stimulus and will eventually swallow and digest it all. At that time the economy will grow – especially if we quickly introduce a fiscal restructuring that deals with future deficits and debt. Krugman might call that austerity but I call it common sense. 

Shakespeare 's Comedy Plays Out in the US Government

On Sunday I watched CNN until I thought I was going to choke from excessive theatre. If Shakespeare was alive he would have applauded loudly at the farce we call Washington. I am not sure which play the current cast of characters would best fit – A Comedy of Errors or All’s Well that Ends Well? I won’t say a lot more about these plays since I read the Clift Notes versions at best as a freshman at George Tech in 1911 and don’t want to give away my total lack of understanding of the arts.

But you have to admit without actually being a Buddhist monk that these politicians are missing the big picture. No matter how you look at this thing what was once billed as a renewal of the Bush tax cuts is now the world’s most laden Christmas Tree. The unfolding legislation is a really bad deal for all of us. Yet the stage production repeated with excruciating analysis by the press and Internet conveys how and why it is of the utmost urgency. I don’t agree.

As many of the Ds and Rs and journalists hold hands and sing one more kumbaya we are lulled into a warm sensation that this compromise bill is going to stave off a double dip recession and be just what Dr. House ordered to reduce the unemployment rate.  But are we really holding their feet to the fire? Will the bill do what we hope? Here are some things to think about.

•      The bill, even with all the new ornaments they are adding, will amount to a very small stimulus. It mostly keeps tax rates the same in 2011 as they were in 2010? How is that a stimulus? How is that going to significantly reduce the unemployment rate?
•     The bill in any manifestation will definitely add to the government deficits in coming years. These additions to an already bloated government debt pile certainty leads to even more uncertainty about interest rates and the soundness of federal, state, and local governments. Of course, you can translate that business uncertainty into a virtual certainty that you, I, and Mr. Jones are going to pay higher taxes at some point in the future. 
•      This bill does absolutely nothing to reduce the explicit and implicit debt obligations coming from Social Security, Medicare, and Medicaid. And it does nothing to reduce or control healthcare costs for those who actually pay for their healthcare.
•      Have you heard of bond vigilantes? This terminology is a colorful description of the people and institutions that make their living trading bonds. Call them geeks or greedy they have the tools and rights to decide when bonds are no longer a good deal. Most of us buy bonds and hold them to maturity. But sometimes we decide to sell them before maturity and it is these bond dealers who form a market so we can do that. We like them when they buy the bonds we no longer want so that we can buy villas on the Croatian coast. Anyway, as the US debt gets a big as Roseanne Barr’s belly, we recognize that there are way too many bonds out there and this should lead to a fall in the price of bonds. Knowing that – a lot of us want to sell these bonds before they lose too much of their value and the bond vigilantes are leading the charge with their faithful dog, Rin Tin Tin. No offense to Lassie. As bonds become as cheap as kimche in Korea, the returns on the bonds soar. Another way of saying this – it takes a much higher interest rate return to get people to hold all this kimche. Viola (or to you unsophisticated people who cannot spell in European, Walah) – the higher interest rates then act as an impediment to people who want to buy new houses and firms who want to buy new equipment. It generally slows things down.

So let’s summarize the above. This new legislation will not be a big enough stimulus; it will make the US debt larger; it will create more uncertainty; it will raise interest rates; and it will reduce spending on housing and investment. Hmmm.

You might be fuming at this point and say, LARRY, IF WE DO NOT PASS THIS BILL WE WILL GO DIRECTLY INTO A DOUBLE DIP recession. The capital letters implies that you are yelling at me or that you hit the Caps Lock key by accident. It is taken for granted by EVERYONE that if we let tax rates rise in the coming year that we will go directly without collecting $200 dollars to the square titled “Recession”.  So I have two things to say about that. First, this is not 2007 and we are not in free fall. While the economy is not growing as fast as we would like right now, it is growing and we are not in the same kind of panic situation as we were a couple of years ago. We do not need desperate policies. There are plenty of green shoots showing that the US economy is improving and as I have said in many past posts – we need to heal the housing markets and financial problems before the economy really picks up. This recent legislation does nothing directly to heal housing or finance. As I said above, passage of this bill does very little while creating very large risks.

Second, I am not advocating doing nothing. In fact, I would go along with some well-placed stimulus as long as it was coupled with Angelina Jolie.  That’s not right. I mean so long as some stimulus was coupled with a plan for long-run fiscal balance. I don’t need the long-run plan to start impacting us today. Too much austerity right this minute might not be good. But I do need the Plan to be legislated tomorrow with its first real impacts starting a few years from now. By legislating a plan today with impacts starting tomorrow – means we all can start planning today. That longer-term plan could have some elements of very short-term stimulus within it. But the longer term plan must show how we are going to pay for it in the future.

A good friend of mine had knee replacement surgery last week. He needed some pain medicine to get through the first week of recovery but soon he can get by without it. He knows that he has ahead of him several weeks of lingering pain and tough rehabilitation. By any definition, that plan for rehabilitation is tough and nothing to look forward to. But he knows that it is the only way to a recovery that allows him full use of his knee and leg. We in the USA can pretend that we don’t need a rehab plan yet, but the truth is that our government is giving us pain pills and are afraid to have us think about the future. We are better and tougher than that. We need better leadership and we need to make sure they know that. It is easy for them to legislate another round of morphine. Let’s not let them do that without also being very clear about what we need to grow again. 

The Fiscal Circus Has Two Rings

Now that Congress is making a little traction with a framework for fiscal policy, let’s not get carried away with dangerous partial solutions. It is one thing to keep the patient out of pain with an injection – it is quite another thing to apply the remedy to his problem. So let’s not get so excited about the easy part until we see the rest of it.

Any good circus has more than one ring.  In Ring 1 we have Congress working on an extension of the Bush tax cuts beyond 2010. That’s akin to a shot for the pain. In Ring 2 we have the serious stuff – a solution to fix our debt problems and therein address unemployment and economic growth.  It seems strange that the public has been so divided about Ring 1 since it is the easy one. Both democrats and republicans have joined hands in a holiday chorus and are singing a Hail Mary designed to focus on a possible deficiency of aggregate demand in the short-run. They had their little spats. The Ds don’t like it when stimulus includes the behaviors of high income earners – while the Rs don’t like the stimulus coming largely from the lower ends of the income scale. But let’s face it – they both get to go play on the monkey bars and jungle gyms at recess if they pass something before January 1. The public is going to shower them with love and kisses for saving our nation from a tax increase in a slow growth period with high and stubborn unemployment.  So it is unsurprising that they will find a consensus on the Bush Tax Cuts.

I am not against Ring 1 and am not against the general notion of keeping tax rates low right now. But I do see this as akin to a good dose of Demerol with no surgeon in sight. Ring 1 is okay so long as there is real action in Ring 2. This conclusion is based on one simple point – the Ring 1 solution will do little to reduce the unemployment rate without a satisfactory solution from Ring 2. Ring 2 contained the National Commission on Fiscal Responsibility and Reform. It went home with a few trout in the boat but not enough to start a real fish fry in Congress. It is true that 60% of the members of the commission voted yes to the spirit of a feasible but imperfect compromise law to attack our escalating government fiscal woes, but that wasn’t a strong and clear enough message.  Ring 2 is in limbo right now. The surgeon is not to be found.  Even if the Commission failed to get the required number of votes, it is still possible that the President and Congress can continue the work in Ring 2. So all is not lost.

While all is not lost, nothing yet is gained from a compromise in Ring 1. After all – in reality an agreement to leave the tax cuts in place for next year or beyond is simply a vote for NO CHANGE. The agreement keeps taxes from rising by keeping them the same as where they were in 2010. If we want 2011 to be better than 2010 then it takes some change. So the big question is – what needs to be changed?

Bernanke, Geithner, and many others still believe that the earth is flat. Oops, I mean they still believe that the problem with the US economy is deficient spending. So the kinds of change they are promoting in Ring 1 are fiscal and monetary policies that would stimulate more household spending.  They also believe that the economy has been very unfair to the average person so their preference is to help people with middle or lower incomes spend more. They don’t want to help Gazillionaires.

Another group sees it differently believing that aggregate demand is deficient because firms are hiring too few workers despite some signs of economic revival. Until firms start hiring more, no amount of stimulus is going to be effective. So all we need to do is figure out why firms are so reluctant to hire.  Or in other words, despite the fact that output has gone up in the last five quarters, employment has barely budged.  Why are firms not hiring? Without a significant resumption of hiring stimulus cannot work. First, the unemployed have few resources to spend. Second, even the employed people are reluctant to spend because until hiring picks up they are not sure that they won’t be the next to move to the unemployed pool.

Consider what happens when you hire a new permanent worker. First, the person must be trained. Second, the firm makes an implicit if not explicit contract to continue employment. If nothing else there is a goodwill gesture made on the part of both parties. Third, the firm will increase what it pays into the state unemployment pool. Fourth it will add to the payroll tax paid. Fifth the firm will probably incur expenditure for various benefits – including healthcare and pension. These are not entered into lightly.

Consider the alternative to hiring an additional new worker. Don’t hire anyone! When sales pick up it is possible to work the existing workforce harder. The firm can expect more output during the regular day or it can pay more for overtime. The company might also think harder about how to employ its workers. It might be possible to change its business practices in such a way that the same amount of labor can accomplish more in a given day. Clearly there are financial incentives for firms to not hire more workers. Buying a machine that makes existing workers more productive means not having to pay additional payroll taxes, healthcare benefits, pension benefits, etc.

So why would firms hire more? I love this question because it gets to the heart of economics since it is all about marginal benefits and marginal costs. According to marginal analysis, you hire another worker when the marginal benefit to the firm of one more worker exceeds the extra costs of one more worker. That is, the firm hires more if the increased employment increases its profits.

In a capitalistic system, firms are free to make hiring decisions and they generally hire more to capture higher profits. The government policy question, then, is as follows. If you want more spending, you need more employment. If you want more employment firms need to expect higher profits. Sales are expanding now so you would think that this would lead to higher profits. While profits are rising now the question is for how long? Firms would like some certainty that the recent short-term profits will not vanish as soon as they arrived.

And this is why Ring 2 is so important. To create the increased profit certainty that firms require will take increased attention to the things that might threaten future profits. Historically high government deficits and debt are real threats and all the current fuss over government instability in Europe points to how corrosive this can be. Government could go a long way to reducing profit uncertainty by crafting a solution for the government fiscal mess. This, of course, brings together the recent explosions of debt caused by stimulus legislation, health care, and by the ongoing and fully expected fiscal requirements of Social Security, Medicare, and Medicaid.  It is one thing to make a decision about the future of the Bush tax cuts – it is quite another thing to help firms better understand the tax and other regulatory impacts on them of dealing with the next 20 years of fiscal challenges.

Until you solve Ring 2 we will get no bang from Ring 1. Until you solve Ring 2 you get no decrease in profit uncertainty and no real commitment to hiring. Take no pride in a solution to the Bush tax cut extension until they get on with the real business of government. 

A Keynesian Wolf misleads about the Euro

I thought I had finally settled the debate about the euro crisis with my last post (ha ha) and then along comes this piece by Martin Wolf in the Financial Times (December 1, 2010). http://www.ft.com/cms/s/0/259c645e-fcbb-11df-bfdd-00144feab49a.html#axzz16y45YdFO

My previous post argued that the euro might depreciate more but it would surely not implode. Wolf is a great writer and I usually like to disagree with him because he is a not-so-closeted Keynesian and I am neither closeted nor Keynesian. This article irks me more than his usual writing because it epitomizes really good analysis based on a really wrong premise. His article illustrates what is wrong with much of what is written these days and helps me try to live up to my goal for this blog – to spout off.

The title of Wolf’s article is “Why the Irish crisis is a huge test for the eurozone” and he concludes that by joining the eurozone, a country consigns itself to credit crises. His words of advice to countries that give up their own currencies to be part of something like a eurozone, “… be careful what you wish for: credit crises would replace currency crises – and these are likely to be even worse.” 

He has an elegant explanation for all that. He begins with the premise that it is inevitable that countries with “divergencies in relative costs” would have international trade imbalances. That is, without flexible exchange rates a country with a bump in relative costs would soon find itself less competitive and would soon have a structural trade deficit. A depreciated currency could have come to the rescue and offset the cost change and restore its competitiveness. Sans an exchange rate depreciation in countries like Greece and Ireland, each would be stuck with a trade deficit implying a need to borrow from abroad to finance their trade deficits. This means a larger foreign debt and should a country have trouble meeting the debt at some point – wham bam thank-you mam – a credit crisis would occur. Then –oh my goodness – national prices would fall worsening the credit crisis – and that makes it much worse than a currency crisis might have been (if the country had its own exchange rate).

Since you know I love to use analogies – Wolf’s point is like saying that you can solve the morning after problem for the drunk by taking aspirin instead of Ibuprofen. We can spend until hell freezes over debating which drug is more effective for a hangover (I prefer a nice strong Bloody Mary myself). We might even find that one of them is better for hangovers. But the only real solution for a hangover is to not drink so much and to not dance to 1970s disco music like John Travolta wrapped in colorful beads with a lampshade on your head. My point is that Wolf is writing about “effect and effect” rather than “cause and effect”. His defect is in his focus on effects without causes. He shifts our attention away from the real problems to a choice of medications.

When this very intelligent man analyzes the issue of the euro, why does he not once – not one single time – does he not go back to the idea he starts with – the cause of it all – the change in relative prices? Why – because he is a closet Keynesian. They usually ignore the original problem. They see any problem as an excuse or some clever ploy to get the government involved by spending more. After all – there are so many things the government could be doing if they just spent more!

If a rise in relative costs and prices causes a country to lose competitiveness – I ask – then why cannot this country work directly on reducing its relative costs and prices? Would it be impolite to even ask this question?  If a country is made more vulnerable because its households go on a spending spree and forget to save; if a country’s government goes on an economic development spending binge that reduces national saving available to corporations; if a country’s companies get lazy and don’t invest in the right technologies or products – in all these cases its competitiveness will be reduced. But notice that in all these examples of cost disadvantage there is a direct cause that could be directly addressed if politicians had the cough-cough sincere interest or kahunas to investigate. But that is too hard for them to do. All that discussion of details might not fit on the teleprompter. Rather than take a real educational and leadership role about a complicated problem – it is much easier to advocate a policy to increase government or household spending.

In this particular case Wolf is blaming the problem on a single currency. If the poor babies only had their currencies back then the boo boo would go away. NO IT WOULDN’T AND READING ANOTHER CHAPTER OF DR. SUESS WON’T HELP IT GO AWAY. If those weakened countries had their currencies back their exchange values would plummet towards zero and contribute to a generally hysterical situation. The rapidly declining currencies would lead to large and rapid outflows of portfolio and real capital. Declining currency values would make it more impossible to pay off their debts.  Maybe you have read about past currencies crises? They do happen – and it seems to me they happen a lot more often than credit crises.

But I don’t want to get sucked into Wolf’s trap. It isn’t about the currencies. It is all about the CAUSES of competitiveness changes. If countries lose competitiveness for fundamental reasons then their leaders ought to decide what those reasons are and address them. Debating whether European nations would be better off with or without the euro misses the target, misleads, and misdirects our energy. Policymakers should not be discussing a euro break-up. They should be discussing the regulatory, housing, financial, spending, and saving practices that led to their current predicaments. If leaders don’t get this right then they ought to be replaced. I hope our own policymakers in the USA get this message too or 2012 could be really interesting.