Wednesday, August 31, 2011

Micky and Goofy Duke it out at Disney World

Let’s suppose you are at Disney World with your kids and you see Goofy and Mickey outside the It’s a Small World ride in mortal combat against each other. Before you know it, all the other cartoon characters have taken sides and now you have a real gang war going – hair pulling, tail tweaking, and everything! This is NOT why you came to Disney World and this scene is not anything you want your kids to see. You feel pretty helpless because it might take some time to notify the park management to stop the fracas.

That helplessness is what many of us feel about Washington right now. Elections are off into the future and meanwhile we have to watch selfish politicians demolish our country. It ain’t pretty!

It doesn’t take a genius to recognize dysfunctional government and its deleterious effects. Even the President underscored this point. But he is not above the fray. His bus tour was more about reelection than healing or else he wouldn’t have said millionaire/billionaire about a zillion times a day.  “Mommy – Charles hit me first.” Charles retorts,” No Mommy, Pete hit me first.” Who cares who hit first? The truth is that both parties are out of control. They both need extended stays in time-out.

The Rs cling to a notion of no tax increases which at minimum is an undefined statement. Despite its lack of clear meaning it serves as a war cry that rallies the troops. The Ds attain the same pitch by screaming about rich people. Again, no one really wants to define a rich person but the message is pretty clear. This is enough to get the smoke rising and the tribes chanting. Thanks to 24 hour news/entertainment the politicians who most effectively promote this environment of misinformation and hatred get the rewards of air time and notoriety.

At the heart of all this is something of value – determining to what extent liberal and conservative ideology is promoted. We all know that legislative manifestation of ideology swings back and forth from left to right and this is probably a good thing. It is dizzying but it is doable. This bickering across parties about their ideological bases is both desirable and expected. But somehow this got out of whack. It is worse than usual and it appears that nothing will get done before the election to improve things. Like good Tar Heels (of North Carolina) both sides are stuck in place with little hope for change.

What burns my butt is that the discussion is so disingenuous and harmful. At the heart of the bickering is the extent of entitlement and how you pay for it. To portray entitlement recipients or millionaires as somehow less than human is wrong and damaging. Worse yet – to act as if taking money from the rich and channeling it to entitlements will somehow improve the plight of the disadvantaged is extremely na├»ve and harmful.  Can the rich pay more? Sure. But in the way things are now being handled you cannot blame the rich for reacting negatively. There is more than one way to catch bees…

I am reminded of the issue of handicapped parking. I was in a parking lot at a strip mall the other day and noticed this obviously handicapped woman limping in from a distant space. Then I noticed that even though there were a large number of handicap spaces, they were all taken. It seems that nowadays almost everyone has a handicapped hang tag – people with real but minor permanent handicaps get hang tags and people with temporary health issues often use their temporary tags much longer than necessary. No matter how fast they increase the number of special spaces – there are more people wanting them. Is that what the original law imagined? Did we really want to create a new and escalating entitlement called handicap? I don’t think so and I felt really sorry for the limping lady.

What am I saying? Basically that our entire entitlement edifice needs to be looked at again in terms of real needs. It is possible to be a D or an R and believe that we are NOT doing a very good job with respect to people in our society who need help. It is also possible to admit that we are helping people at a very high cost who may not really need the help. By the way, I would apply this very same argument to military spending. We REALLY need to look at the effectiveness of all dollars we spend as a nation.

But you know, it isn’t going to happen because Mickey and Goofy are shouting at each other. What happened to our country that we have rewarded those who would rather get air time than actually do the work they are paid to perform? Real entitlement reform and fair tax reform are possible but it won’t happen if our leaders reduce their public and private communication to such enlightening conversation as we have been hearing. Hey R you guys are mean and rich and you gotta pay more taxes. Hey D you guys are dumb and you ain’t gonna get my money. It’s my money and my mom said so.

My next blog post will get into how and why things have deteriorated so far and maybe what we can do about it. For the time being, instead of focusing all of their attention on finger-pointing it seems to me that the real leaders ought to be stressing how similar and interdependent we all are.  Boys and girls are different but they both are human beings and have more in common than differences. A policy to stamp out men sounds like fun at a girls night out but surely the next morning they would realize that they need us guys for a thing or two. The same goes for liberals and conservatives. Neither party wins by mortally wounding the other. Both parties and the country will gain when they begin to earnestly emphasize how we benefit from each other. Maybe Goofy and Mickey will find a way to lead us out of this mess.

Tuesday, August 23, 2011

Nixon Rides Again. Will panic rule policy again?

As the President and Congress take R&R after a grueling year of doing nothing, we might want to ponder what is going to come next in the way of policy. In the Financial Times letters to the editor section on August 22 there was a letter explaining that orthodox economics was no longer applicable – we need to try some novel approaches for our current economic problems. The President leaked that he has a great new plan that will be released with great fanfare at a future exciting prime time press conference.  As we all wait with bated breath, we might want to recall the 1970s. The 1970s are known for many things. While disco often comes to mind and I could write a whole blog about why I loved and still love disco, my macro background makes me recall the 1970s for macro reasons. For example, we had three recessions during the 1970s. The term stagflation was coined in the 1970s to describe a new form of economic disease that found inflation and unemployment rising at the same time. Perhaps as a result of the latter my most salient memory of the 1970s is how stupid macro policy was. And that brings us to today. I think we learned a lot about stupid policy in the 1970s and we are about to repeat those errors again. Why? Does history have to repeat itself? I wish it wasn’t so. But when people start to panic our friends in Washington feel obligated to follow suit. Unlike times when leaders like Roosevelt and Churchill met crisis with level heads and big cigars, our leaders run to Twitter and Tweet about how the other guy is a big poopy-head.

Nixon was a conservative guy. At least that’s what we thought. But then along came stagflation. Arthur Burns said to Richard one day – Richard, let’s go break into a building. No, just kidding. Burns said, Richard – if inflation is increasing you have to reduce spending. If unemployment is increasing you have to increase spending. Richard wasn’t dumb so he asked Burns what happens if inflation and unemployment were both rising. Burns put down his stogie, peered out the window and said, Richard I suggest you find another job. We don’t have any theory about what to do in that situation. Richard then discussed the matter with several hanging portraits and came up with a brilliant solution. He would out-do the Soviets. He would control every price and wage in the USA. It makes sense, right? If prices and wages are rising too fast, then just put a lid on them. He could ask Burns to juice up the money supply and increase spending while at the same time telling workers and firms he would cut off their heads if they raised prices.

Nixon imposed the Wage and Price Controls starting in August of 1971 and finally ended them in 1974 after almost destroying the US economy. Nixon didn’t count on several things – I guess that is what you call the law of unintended consequences. For one thing, businesses mostly found ways to get around the controls. As usual, the bright folks get by just fine. For example candy producers discovered if you made the candy bar smaller they could raise price per ounce even though the price of the bar remained the same. So we mostly ate smaller candy bars and drove in lower quality cars. The price index showed no change but we were definitely paying more for the things we wanted. Second, as OPEC was starting to flex its muscles, Nixon realized there was little his controls could do to stop the impending impacts on prices of oil and food prices. Yes food, the ugly cousin of energy, had also raised his pimply head as droughts and other calamities had cattlemen shooting their herds because they couldn’t afford to feed them. They did not shoot their teenage kids thankfully because there were laws against that. As a result the never successful W&P controls started making exceptions and were never the same again. Of course since Nixon was also the clever guy who ended the Gold Exchange Standard, he had to deal with the effects of a declining dollar on the cost of QE2 Transatlantic cruises and a variety of other things US citizens wanted to buy from abroad at rising prices.

Hindsight is fun isn’t it? The lesson in this case is that since policymakers were confused about the economy they started doing new and crazy things. The crazy things probably made the economy worse instead of better. It is no accident that both inflation and unemployment increased in the mid-70s and then again in the late 1970s. Nothing Nixon, Ford, or Carter did had much impact. At least nothing they did had much impact until they actually did the right thing. Carter gets some credit as does Paul Volcker, in that regard.

The right thing is just sticking with basic common sense. One had to be high on their drug of choice to not see in 1970 that the US economy was suffering from rapid growth in spending. You don’t need supply-side gurus to know, even in 1970, that the aftermath of too much government and private spending would be inflation followed by rising business costs. Recall the Vietnam War and the War on Poverty? Inflation was just about zero when the 1960s started but it predictably increased through the decade as it became clear that aggregate demand was lurching ever higher as buyers and sellers began to incorporate higher inflation expectations into their spending and wage behavior.

 It is too bad that we waited so long to do the right thing in the 1970s. It’s like deciding to lose weight only after you doubled your hulk. Things might have gone a little easier if you started to attack that mound of frivolous flesh after about a 10% gain. Anyway, it took until the end of the 1970s before Carter started to tighten the government budget and Paul Volcker raised interest rates to over 20%. That was no fun. But the diet eventually worked. Reagan then discovered supply-side economics after a hot weekend with the gorgeous Maggi Thatcher and that helped to address the problems with the cost side. Viola – tight money with some attention to supply side led to more stability in the next decade.

If we learn from history my guess is once again we won’t do the right thing. Our Washington folks will embrace some lame but popular excuse for a policy and we will live the next five years with all the unintended consequences. I am happy that the President and Congress are on furlough. If they would just stay there until November 2012 we might all be better for it. Doing nothing will look good compared to the novel and fun programs they are about to unfold. 

Tuesday, August 16, 2011

Macroeconomics: Fairy Tales can come true and so can Nightmares!

What is real and what is fantasy? I think most of us know the difference. The gym I go to has mirrors on most of the walls and despite trying not to actually look at any of them I do once in a while see my entire hulking mass. That is reality despite the fact that it is just a reflection off a glass. Then I close my eyes and imagine the future LSD with the tiny waistline and six pack abs.  Betwixt the fact and the fancy I am motivated to do one more set of sit-ups before adjourning to a sumptuous lunch. This introduction about reality and Fairy Tales brings us to Macroeconomics and GDP. It also brings us to today’s economic difficulties and why our traditional policies seem to make things worse.

GDP exists only in the minds of theoreticians and mathematicians. No one has even bit into a GDP and no one has ever paid a CPI. These are abstractions or fantasies – just like an image of me with a waistline– the fantasies do not in fact exist. But fantasies can matter. Fantasies can be very useful or very devastating. If images help me to be more healthy and youthful then they are valuable despite the fact that they are pure fantasies. If these same images cause me despair and depression, then they are not so helpful. Either way, they are impactful.

GDP is defined as a nation’s output – it is a number that we get by adding up everything that was reported as produced within the borders of a nation. While it is a real concept it has no physical counterpart that we can associate with it. Just imagine all that stuff that got produced last month in a big pile in the street in front of your house. Our imaginations run wild as we think of this one thing that is the result of somehow melting down or bolting together every good and service that got produced that month.

Okay? So a GDP is a concept or a fantasy and is nothing you can really sink your teeth into. The nation’s price level is the same. So is the nation’s interest rate, unemployment rate, exchange rate, and so on. In fact, it is worth pointing out that a nation is also a concept and not so much a real thing. Wikipedia says “… a nation may refer to a community of people who share a common territory and government; and who often share a common language, race, ...”  Try to bite into that!

It is important to do two things with respect to these macro fairytales – first admit that they are not real and second understand to what extent they can be useful (or not). Dr. Seuss books are about fantasy characters that never existed – but they sure did a nice job of helping me put my kids to sleep. The headless horseman of the Legend of Sleepy Hallow, in contrast, wasn’t always the best thing to read right before bedtime! What I try to do in this posting is to argue that today’s situation macro policy is a little more like Sleepy Hollow than Dr. Seuss. Despite what a host of so-called macro experts are saying today, we would be better off ignoring macro and focusing instead on the “little pictures.”

So as a card-carrying macroeconomist let me be the first to admit that GDP, CPI and other things I teach about are figments of our imagination. None of us buys all the goods and services that get produced and few of us directly experience the calculated cost of living. When the unemployment rate is 9% only a small fraction of us experience the actual state of unemployment. And while we might live in Indiana many of us might share more personal characteristics with people from Poland or Canada than the yokel who lives down the street and let’s his dog bark all day (and sometimes all night).

While Macro was A TOPIC OF CONVERSATION BEFORE Sir John Hicks invented the IS/LM Model, that innovation can be given a lot of credit/blame for the propagation of Macro’s usage. For example, Keynes’ widely read and quoted General theory of Employment Interest and Money was instrumental in popularizing macro by focusing attention on national macroeconomic policy. But it took Sir John Hicks’ representation to create an academic or classroom revolution. Before Hicks, Macroeconomics was mostly story-telling among a small group of intellectuals. Today we have Hicksian models taught to millions of university students each year. Each of them learns a model – sometimes offered in mathematical equations but more frequently portrayed with graphs. The star players of these models are labeled Y and r. In expanded versions of the Hicksian IS-LM models are also found N and P. The focus of these models is what determines a nation’s output (Y), interest rate (r), employment (N), and price level (P). Economists and journalists have used these models and similar variants to analyze and debate the roles played by monetary and fiscal policy in generating superior paths for these variables.

Without getting into macro policy debates, let’s agree that whether you attribute this all to Keynes, Hicks, or a host of other great minds, the truth is that they collectively defined and gave us a set of unreal concepts by which to measure the performance of a nation’s economy. They also gave us a set of debatable doctrines that helped us approach the questions of if and how we might improve the nation’s economy.

For example, if measured GDP was forecast to fall by 10% next quarter, we would all be very concerned. Some segment of our population would immediately ask the Fed to begin an expansionary monetary policy. Others would ask for income tax cuts. Still others would prefer a government spending program that enriched entitlements or spent more on shovel-ready projects. These approaches are designed to remedy problems that have broad impact and might be appropriate. But just like you don’t take a bubble bath to wash your hands after a trip to the restroom – macro policies are not always the most appropriate remedies when problems do not stem from macro sources.

If the only tool you have is a shovel, then you are ready to use a shovel for any or all your problems. If you learned a lot of macro, then you are quite ready to approach economic problems as if they could all be remediated by monetary and fiscal policy. But that was never true and never will be. While our macro indicators like GDP are by definition impacted by almost anything, the truth is that the sources of many problems are not national in scope and are not macro issues for the USA:
                A real estate collapse in New York
                Banks failing in California
                Canada stops buying US exports
                The inflation rate hits 10% in China
                US consumers decide to take more Mediterranean cruises

The solution for the person with only a shovel is to buy a saw and a hammer – because some problems are better handled without a shovel. The solution for a country’s economic ills is to realize that not all economic problems are macro problems requiring macro solutions. Some problems are better handled directly.

Despite the fact that some of today’s political leaders cannot walk two feet without mentioning changes in the distribution of income or the plight of the poor, how many of them have fashioned a comprehensive policy aimed directly at the sources of poverty and income inequality? It seems easier to call for tax and spending policies that continually press the entire economy to grow faster. But this is an extremely inefficient way to help a minority of the population catch up to the rest and totally ignores those factors that perennially keep them behind.

Y, r, N, and P are all valuable macro indicators and have their place in policy. But just like a flat tire does not necessitate a full overhaul of the car, changes in these macro variables do not always indicate a need for a national macroeconomic policy. Perhaps if we understood this we would make fewer mistakes and take better care of the peoples’ money.  Could we have averted the last recession if we had paid attention to our knitting? Did real estate need some attention before the bubble burst? Was excessive financial leverage not something that could have been addressed? Could we have worked harder at free trade agreements? Could we have paid more attention to imbalances in global commodities markets and adjust our energy production/uses with specific policies?

Macro is a fantasy but a useful one. But like many useful things it can be used wrongly or poorly. Today we suffer from macro-mania as we struggle with the aftermath of a deep financially-induced recession. Abnormal psychology makes the point that it is the extreme or special cases that help us better understand normality. We are learning from our special situation today that macro tools do not work as well as we thought they would. Maybe it is time to realize that not every problem needs a shovel and not every economic problem is macro. We have a lot of tools we just need to use them. 

Wednesday, August 10, 2011

TC is PC for Monetary Policy

I learned a new word today – TC. TC is not really a word but it is already being bandied about in the news – Time Commitment.  I have to admit that in all my years of teaching macro and money I never once used that term. Apparently TC implies a promise by the Fed to keep interest rates low for two years. It is kind of like me promising to not eat giant ribeye steaks for two years… it sounds like a sane thing to do but it probably ain’t gonna happen.

That is not to say I am not relieved that the market headed upward yesterday. I appreciate that. But like many things in this world, I am not completely convinced that the relief investors felt yesterday is going to last. I know – you hate it when economists spread gloom and doom – but let’s face it – TC really means two things. First, it means that the Fed did almost nothing yesterday. Second, it means that the Fed raised – not lowered – the riskiness of our economic environment.  I started writing this BEFORE the market opened today but I just looked and it appears that the DJ is down almost 400 points!

Promising to keep interest rates low for two years seems to have reassured frantic investors for a moment but what have they really done with this promise? They did nothing insofar as policy goes to reduce interest rates further. They did nothing to change the amount of reserves in the banking system. They did nothing to generate a new loan or make banks more willing to make loans. They did make a promise – one that cannot and will not be kept. What we most care about for economic activity is longer-term rates and the Fed has no magical or direct influence on these rates. They are set in markets. When the economy slows down or when inflations expectations decrease – interest rates decrease. When the economy speeds up or if inflation signals higher future prices interest rates often rise.

In short TC might be PC (since it appears to have assuaged investors for a day) but it didn’t do one positive thing. But it does promise to come back with a royal boot to the national buttocks. Did you hear anyone saying last week that the reason all hell was coming unglued was because interest rates were too high. I don’t recall because I was being run over by debt ceilings and government debts and Chinese inflation and several other things. But nowhere in that economic haze was anyone crying about high interest rates.

So what gives? Some analysts are pointing out that the economy is very weak. They believe that the Fed’s actions will somehow strengthen the economy and therefore have a continuing positive effect on the stock market. But if trillions of additional reserves supplied by the Fed during the last two years didn’t work, then why would a silly commitment to keep interest rates low for the next two years have any impact on anything?

The most tragic thing about what they did yesterday is that they scared the hell out of us by underscoring two points. First, they admitted that the government has no more tools to use to stimulate the economy – even in the short-run. Second, policymakers at the Fed are so alarmed at the current weak economy that they have to drum up a silly policy that everyone knows has nothing to do with our current ills.

We all know why the market fell and we all know that it has nothing to do with interest rates that are too high. If our problems today have anything to do with monetary policy, they probably stem from too much outstanding money and the risk of higher inflation. Some economists have clearly pointed out that inflation is one of the few ways to “solve” our debt overhang. Rating agencies have also been very clear that such a policy will only lead to future downgrades. So if anything, a policy that ends up with even more monetary policy stimulation increases the risk of more trouble down the road.

Finally, the problems in the market are probably more dominated by non-monetary factors. By admitting that all we have left are monetary tools – we once again take our eye off the ball. If this monetary action takes the heat off Washington and stalls or prevents them from IMMEDIATELY solving our deficit/debt/regulation issues – then the public will once again be duped by our snake oil sales staff in DC. The market seems to be recognizing this fact this morning. But today’s market performance is not the final judge – what matters is the future course of the economy.

I read and heard experts saying that the Fed just HAD to act! They had to show that they are very concerned about the economy. I am afraid that the combination of the government’s inability to act and the Fed’s over-willingness to save the day underscores just what is wrong with our country. This has got to be the height of national irresponsibility. 

Thursday, August 4, 2011

Marshall Dillon – Doing the Wrong thing for the Right Reason

Some of us older folks grew up watching a television show named Gunsmoke. Marshall Dillon was always the good guy. Inevitably there were always at least two bad guys getting into an argument in Miss Kitty’s bar, the Longhorn Saloon. She and the Marshall seemed to have a thing for each other. Anyway when the dusty bad guys would drink a little too much firewater at the Long Branch Saloon they inevitably got into highly intellectual discussions and heated debates. On many shows the first cowboy accused the second of having an ugly horse. Can you imagine such a provocation! This led to both cowboys going into the street, drawing their six guns, with the result that one of them ended up being dragged away by Chester, Mr. Dillon’s sidekick. This was where we Boomers first learned about doing the wrong thing for the right reason. No good man could let the reputation of his horse be soiled. So the right thing was to protect the reputation of your steed. But please, killing someone to protect your horse seems a little extreme. I don’t know if this kind of thing really happened out West in those days, but if it did, it seems pretty hard to defend on the surface of it.

Don’t get me wrong. I am not against extreme actions and even killing has its place. Getting Hitler and/or Bin Laden are examples of doing the right things for the right reasons. But I am against wrong things even if they are for the right reasons.

So let’s get to it. Many democrats often say they stick up for the poor and the middle class.  That’s almost a way to identify or define democrats. They never let a good party or a drink go by without mentioning all the good things they want to do for the poor. I think it is a good thing that democrats play this role. It is the right thing for the right reason.

Republicans often stick up for entrepreneurs and investors – big or small. They worry about the free enterprise system and they defend the Constitution. You won’t be in a golf foursome of republicans and not hear how they defended the capitalist system. I think this a good thing that republicans play that role.

So let’s begin this little story by admitting that our government representatives have good goals. I doubt that you would ever hear many democrats say that he or she wanted to ruin the capitalist system. And I don’t think republicans want to hurt or punish the poor. Both sides have admirable goals.

While there are often political and economic tradeoffs as the democrats and republicans duke it out for their chosen constituencies year after year, the result of all this politicking is an economy that generally grows and provides jobs and is one in which some groups get more entitlements than others and some people pay higher taxes than the rest. These results kind of ebb and flow: During one time period the pendulum may swing toward more benefits for the poor and middle class and typically that phase will be followed by a time when the opposite occurs.

The trouble comes when we have years like this year in which these politicians simply do the wrong thing even though they are, as usual, doing these things for the right reasons.  Take the republicans first. In trying to protect the economy they want to see major cuts in government spending. They believe that taxes should not be part of the solution for a large debt because they believe future government will figure out ways to spend all that tax revenue and more and soon we will be back with debt growing. I see nothing wrong with that position. But in a time when republicans are a minority of the government they cannot enforce their will. The usual thing when you are a minority is to forge a compromise where you try to get most of what you want. Trying to do more than that can be very harmful. In addition, while the long-run health of the economy requires a significant cut in spending, doing so too much too soon could jeopardize the speed and strength of the current economic recovery. They were doing the wrong thing when they held the debt ceiling hostage.

You Rs are now wanting Marshall Dillon to shoot me down on Main Street. So let me now turn to the D’s. In trying to protect old people, college students, poor people, union people, and people who do not own their own jets, they are doing the right thing. Those people have seen their incomes and wealth fall both in absolute and relative terms. These people are struggling and it is good that the Ds point this out and represent their interests. 

But even some of the wackiest Ds have to appreciate that the poor, the elderly, students, and others regular folks would do a bunch better if the entrepreneurs and investors were a lot more optimistic about the future. Aiming their ammo at higher taxes for the latter does little to help the people they really want to help. And a lack of sincere and specific attention to limiting government spending does not help solve longer-term issues. Sticking their heels into the mud on entitlements and holding tightly to higher taxes on the rich seems the wrong approach. While the Ds hold the majority of the government now, their own tenacious approach just hardens the rigidity of the Rs. The Rs cannot win but they can surely make sure that we all lose.

Why is it so hard for all of these government representatives to see what history shows us? The rich and the poor are not mortal enemies. If anything they are co-conspirators and jointly derive benefits when the right things are done for the right reasons. It is true that in any given time period, they do not share equally in the benefits, but I am guessing that they do better when they work together than when they treat each other like the cowboys did in Dodge City. When the economy is doing well most of this stuff happens:
                Employment and incomes rise across all income classes
                Poverty in both absolute and relative terms declines
               Government spending on entitlements automatically decrease as fewer people are unemployed and people move out of poverty
                Government revenues increase as people and companies earn more incomes and pay more taxes

None of these things are happening now and won’t be happening in the near future so long as both parties do the wrong things for the right reasons. A deal has been made and so far the economic consequences suggest that doing the wrong things for the right reasons is not fooling anyone. As we move to the next stages of debt and deficit resolution we can only hope that all sides come to understand that a divide and conquer approach will do nothing but impoverish us all.