Monday, July 25, 2011

Unexpected Virtue Means the Government Gets to Have its Cake and Eat it Too

It is a tough week for bloggers. Casey Anthony is in hiding for a while. The Europeans seem to have overcome a big debt impasse. Pro football millionaires and their squabbles seem to have been resolved. Glenn Beck has been replaced by The Five at Fox at 5PM and all five seem to think highly of their own loud and comedic antics.  So what is there to write about? Oh yea, that US budget thing. But what hasn’t been said about that topic?

I got into a discussion with a few friends last week that might be worth tossing out there. It has to do with the difference between a technical default and a real one. There’s a big difference. Let’s suppose you want to take $1,000 out of your bank account so that you can buy a new pond for your prized gold fish. You go to your bank which has a reputation of being a profitable and successful firm and the teller explains that you will have to come back in a few days to withdraw money from your account. The bank lent a bunch of money to Bill Gates and they expect him to replay tomorrow. Since it is very likely that Bill will pay back his loan on time, the bank is in a technical default. You might be angry and feel inconvenienced but you know the situation is temporary. You will get your money and soon your gold fish will be swimming in their new home.

But now let’s suppose a very different situation. In this case you go to your bank because you have heard rumors that it has been making loans to gun runners and other rough characters that have not been good about repaying. The bank has a reputation for corruption and mismanagement. Upon requesting your $1000 from this bank they tell you to come back maƱana because they don’t have enough money today and are not sure when they will have it. There is a pretty good chance that they might never have your money. Your gold fish are in major trouble.

Greece is like the second case – a real default. There is a very real probability that private bondholders of Greek banks will not get paid in full. They lent money to the Greek Government but the Greek government is unable to repay despite raising taxes, reducing spending, and making plans to sell the Parthenon and Corfu. The recent EU solution appears to facilitate a Greek default.

The USA is like the first case – a technical default. If government revenues are not large enough for expenditures we borrow from the public. But because of current political issues in the US the government has hit its ceiling for borrowing and the government will not raise the debt ceiling. The revenues coming into the government each month are insufficient for the monthly expenditures but we cannot sell bonds to cover the difference because of temporary political issues. Clearly the US could borrow in credit markets and the US has enough wealth to cover our expenditures. So if the time comes in August when we cannot pay obligations because of the current politics EVERYONE on the planet knows it is a technical default – a temporary situation.

So why does all this matter? In a real default bondholders do not get paid and when they don’t there is a chain reaction of negative impacts that ensue. In the case of a Greek default we know there are many European and other foreign banks that have loaned money to Greek Banks. Thus there will be a global multiplier of lost repayments and negative financial impacts. Along with the impacts on financial institutions will come a wave of declines in bond and stock prices. So Ma and Pa Davidson’s extensive portfolio will be damaged and prevent them from purchasing much needed large bottles of Jack Daniels.   In the case of a technical default none of this has to happen. In a technical default US bond holders whose bonds have matured will be told that they will be paid later. They should believe this even if “later” is not perfectly spelled out. History is not a perfect predictor of the future – but all people need to do is look to the past to see that all US bondholders have been paid. It is true that a technical default could have some important negative financial and real impacts when people who expected to be paid by the government are told to wait for their payments. But it seems to me that this kind of impact, especially if the technical default is short in duration, would be quite small when compared to a true default a la Greece.

So what is the fuss about in the US? Some of it has to do with those so-called bond vigilantes. These are people with chaps and spurs who ride on horses in the Arizona desert and get bored yelling “ye doggie” so they harass profligate countries by selling their bonds and stocks. They sell the bonds and stocks BEFORE the actual default just like you might sell your tired old lawn mower to a perfect stranger who doesn’t know that you haven’t put oil in it since Stage 4 of Nixon’s Wage and Price Controls.  You get out while the getting is good! If too many of these bond vigilantes sell US bonds now, then prices of these bonds will plummet now and this makes a default more likely. It also makes us hate the vigilantes even though they are just following their hunches about assets. Notice people don’t seem to hate the governments that actually created the defaults. But government officials are experts at dodging bullets and pointing the finger of blame elsewhere.

Notice that if the vigilantes are wrong they do not do so well. In the example above they think they are applying the principle of selling at a high price so they can later buy at a low price. But what happens if they are wrong? Suppose the debt ceiling issue was just a matter of timing. Suppose the US government soon solves its political problem and increases the debt ceiling. Suppose they solve it in a way that people believe is real and durable and will lead to smaller future debts and deficits. In that case the price of bonds will go up as people’s faith is restored. In this case notice that the vigilantes will have sold at a low price only to later buy at a higher price. That is a good way to de-spur a vigilante. Notice – when governments do the right thing at times when many people are worried that they won’t – then this is not only good for the country but it robs vigilantes of their ability to profit. It seems to me that our government policymakers ought to keep this in mind. By doing the unexpected virtuous thing they get to have their cake (their own jobs) and eat it too (avert a financial and real crisis). 

Tuesday, July 19, 2011

Welcome to the United States of Europe

 Recent events in Europe have several experts predicting the demise of the European Union and/or the disintegration of the European Monetary Union. Whether the discussion is about Ireland, Greece, Portugal, Italy, or DSK’s dickey, the oft-heard conclusion is that something is about to end. My hunch is just the opposite – humdrum stuff was making the EU/EMU pretty boring for a while but now we see the seeds of an even tighter Europe Union and new steps toward the United States Of Europe. Challenge and fear seem to be stronger motivators of integration at times when hopes and dream fail to spur change.

Let me frame my argument with a review of EU history and please excuse me for leaving out all the details. Please wake me up when this over. If you prefer a more formal (i.e. correct) summary of EU history you might try

·         There were two world wars that for the sake of convenience and generally accepted accounting principles George Bush named them WWI and WWII. These wars found Europeans as enemies and led to recognition by many European countries after WWII that life would be a lot more pleasant if they would find a way to stop killing each other. Estimates for deaths incurred during these two world wars begin at about 50 million. Germany, France, and the Benelux countries decided that if they cooperated in the production of iron and steel that would be a nice beginning. The idea was that economic integration might breed common interests and someday lead to zillions of tourists traveling in VW buses eating French fries gobbed with mayo while dropping gazillions of dollars and yens in GeFrBeNeLux. It soon seemed easier to start calling it the EU.
·         In 1973 Denmark, Ireland, and the UK joined the EU and thereafter other countries wanted to join. The US tried to join but EU leaders explained to Nixon that the US was not actually in Europe and while they appreciated being protected by the US military, they didn’t really like us enough to make an exception to that all-European thing.
·         Other European countries kept joining thinking that membership included Green Stamps. As of today there are 27 countries in the EU. There are another five countries asking for admission. 
·         In 1993 the single market concept was approved into law and that included a ton of legislation that helped form a single market for goods, services, persons, money, and Jerry Lewis.  As these countries expanded their trade with each other it made a lot of sense to remove as many obstacles as they could. A single market means that many national impediments to trade were removed and the economy of many nations functioned as if it was one.
·         In 2002 many of these EU countries decided it would be better to ditch their currencies and replace them with seashells. After some experimentation with this new idea it was felt that seashells were not the best idea so the euro currency was invented and has to date been adopted by 17 of the countries. As the markets were becoming more integrated the costs of having to deal in so many different currencies became pretty obvious. It was a big step for those 17 countries but they did it to make Europe work better.   Without home currencies the control over the new euro would be done jointly by a new institution called the European Central Bank. While the central banks of these countries participate in all ECB decisions, no single country holds a veto over ECB power.  Sovereign policy over money, interest rates, exchange rates and more was given over to an extra-national body.
·         Ever since the adoption of the euro it was pointed out by many experts that it makes little sense to have monetary union without a fiscal union. But then, you could also argue that it makes no sense to have monetary and fiscal union without complete national unity.   The EU has integrated one step at a time and the logic of slow and steady seems more prevalent than these kinds of arguments. I will return to this point below.
·         Along the way the institutional make-up of the EU took form and the EU is composed of a real transnational government with an EU Parliament, a Council of Ministers, A Commission, Court of Justice, Court of Auditors, and a Court Jester (Jerry Lewis). While this set of institutions reminds us of the USA and of American’s national institutions, our EU friends are quick to remind us that this is not a strong federal government and its budget reflects a loose federation with limited powers. These 27 countries have given up national sovereignty in some areas (as defined by EU Treaties) but unlike Alabama and Indiana, these 27 countries remain independent and sovereign nations.

This last point gets us a little closer to my main point. It seems to me that this is a mostly irreversible train that is heading towards USville. I get that these are 27 sovereign nations but I also get that over the years they have given up more and more independence and little of their posturing or behavior now would suggest that 55 years of experience makes them so sure that this was all a big mistake. 

In fact the temperature of the debate over Greek debt underscores how serious they are about saving both the EU and the EMU. Yes these are difficult and heated disagreements. The French and the Germans have very different ideas about how to solve the crisis and are almost as vehement about their positions as they are about soccer. The ECB also has its own ideas about the correct solution.

And they should feel strongly about all this. Why? Because the Greek crisis isn’t so much about Greece as it is about a new round or a new layer of EU control and loss of national sovereignty. It was one thing to allow the EU to have control over laws governing the flow of goods, services, people, and money. It was another thing to create a European Central Bank that replaced the independent decisions of 17 countries over money and meant that 17 countries gave up direct controls over their own exchange rates. It was another leap to change the voting and other rules for making EU decision so that 27 countries would have more equal voting rights.

But despite all that brotherhood and giving up of sovereignty – they still had their own 27 fiscal policies. These countries could set their own taxes and government spending.  Sure, the Maastricht Treaty codified guidelines that said how large a country’s deficits and debts might be. But that was not a real dilution of national control. These Maastricht limits have been avoided on numerous occasions. Inasmuch, Finland had no responsibility towards a German debt and vice versa. And while it was true that an economic calamity in one country could spill over and harm the citizens of other EU countries, there was not a lot of discussion of how that might be handled.  

Well, the Irish-Greek-Portugal-Spain-Italy situation has changed all that. There is a real chance that fiscal problems in one country can severely damage economic prosperity of the rest. They always knew there was such a potential but until it was screaming in their faces every day, the motivation to do something about it held a low probability. While much of the energy is being devoted in the last weeks to EU or world solutions to the Greek debt problem – this situation is better considered as a new chapter in loss of sovereignty of EU nations. It isn’t only about Greece. It is all about a future EU. It is all about how the EU or the ECB should behave in what has become a new and different economic/financial situation. All of a sudden Finland and Germany have a lot to say about another country’s debt and deficits – and how they resolve them. The Finns would not have been so bold a few years ago. Expanding the EU’s policy jurisdiction was not so important a few years ago. But the fiscal hammer came down. It has everyone’s attention.

If one country’s debt cannot be repaid this acknowledgement impacts the euro’s value. If one country has deficits or debts or real prospects of future deficits and debts – the same is true. If Ireland can’t pay, then the economies of all countries in the eurozone will be impacted. Spillovers are not limited to the exchange rates since the financial systems are highly interdependent. If risk suggests higher interest rates in Greece, then interest rates will rise in other EU countries.  Never before have EU countries looked so closely at each other’s deficits and debts.

One solution is to eliminate or remove the bad guys from the EU club. How exactly do you define a bad guy? Even if you could I don’t see expulsion as a reality. History says it won’t. There are countries that never joined the EU – but there are none that have left. The benefits of the Union are simply too strong and the reasons for leaving too weak. A single market and a single currency create enormous benefits and no country once in will want to be out. Being out gives a country more control over its own currency value but let’s be honest – a plummeting currency value is nothing to be wishing for. These countries are in trouble not because of weak currencies but because of bad policy. The better policy will come more easily from within the Club than from without.  Political leaders of one country never want to admit they failed and need help from the other countries. But the situation today requires that they do this.

The European Financial Stability Facility and a European Treasury are proposals that envision a lot more integration and less national sovereignty when it comes to EU fiscal policy. Euro bonds envision a true regional monetary policy. It is hard to predict what will come of this sovereign debt crisis but one can bet that this current challenge will be met like all the past ones – with lots of heat and light followed by a treaty or agreement in which more countries give up more sovereignty for the purpose of overcoming another challenge to a successful economic experiment that has now lasted more than half a century.  The EU is still a long way from being as integrated as the 50 states that comprise the USA – but they promise to move closer to not farther from that model as time moves ahead. 

Tuesday, July 12, 2011

Much ado about June’s Employment Report

In Much ado about Nothing by Shakespeare the villain Don John fools the two loving couples and just about destroys their relationships until Constable Dogberry uncovers the devious plot and the two couples marry and live happily ever after. I am no Dogberry but I have to say that Shakespeare’s ideas are once again being played out in front of us. This time the context is the jobs report of last Friday.

If you were not on the last shuttle launch and have at least one eye and one ear you heard/saw all the commotion after the US Labor Department announced its employment numbers and unemployment rate. You might have thought that Casey Anthony escaped from prison and robbed a 7/11 or something. Imagine all you heard Friday about those numbers – numbers that were close to what most people expected and numbers that relate to only one single month and numbers that will be revised in another month.

Mr. Davidson – we have analyzed your blood and your cholesterol count is above 203.7!  CALL IN THE TEAM OF HEART SURGEONS FROM BLOOMINGTON REGIONAL HOSPITAL! Geez guys, everyone knows that my count has been above 200 ever since I discovered $8 per pound rib-eyes at Sam’s Club. Everyone knows that my count was high last month. Luckily my family isn’t like the locusts that rule the airwaves and Internet. No hospital visit for me. Another dose of JD on the porch at sundown, the din of the neighbor’s dog barking, and let’s wait and see what happens in six months.

Let’s get back to the June Labor Department data release. There was very little good information in the report. EVERYONE knows that this recovery has been slow and threatens to continue to be slow. Is it really news when another data point confirms that? President Obama says that he should have warned us about this slow recovery a long time ago. No kidding. He should have. But he didn’t despite the fact that many good economists were telling him that from the very beginning. Why didn’t he listen o them? Because he wanted to be the knight in shining armor and save the damsel in distress with his poorly crafted and poorly executed stimulus programs. That’s why. Now he wants it both ways. His stimulus leaves us a little less than where we should be after a huge and devastating financial collapse. If his policies had actually addressed the causes of collapse then we might be in a slightly different and better place now. But don’t fool yourself. If it took 10-20 years for the financial problems to develop – we weren’t going to solve them in two years!

So much for President Obama. The Republicans are not much better. In closed doors they are giggling out of control and cannot restrain their glee when they get in front of the cameras and chant over and over and over – the economy is getting worse and Obama didn’t do a thing to make us better! They see this as a great opportunity to gain political advantage. But what did the Republicans do to clearly and forcefully deal with the causes of the financial collapse? Their jollies or priorities have been pretty clear at the national level during Obama’s rein – attack health care, rant about abortion, spout about energy policy, and rail against higher taxes. While every one of these issues deserves its day in court, the Republican emphasis on them reveals very little work by either party to dig into the causes of our current malaise.

Friday’s exaggerated response to the jobs report brings out another round of knee-jerk stupidity.  Laura Tyson, chair of the Council of Economic Advisors under President Clinton, wrote in the FT last Friday that” Only Further Stimulus can tackle America’s jobless wage-less recovery. “  President Obama now wants to accelerate plans for a national infrastructure bank. Both Tyson and the President have their causality reversed. Look Laura – there is blood oozing out of that bullet wound, noted the President. Yes, sir, I will push the blood back into the whole. Think of the logic:
B    Blood coming out of a bullet wound is bad
·         So pushing the blood back into the body is good.

You say, Larry, what have you been drinking at 9 am in the morning? I say, none of your business – but please note that the logic of Laura and Barack are the same:
       Employment worsening in the US is bad
·         So pushing employment higher is good.

Why are these two claims both wrong? Because in both cases there is the famous missing X variable – THE THING THAT CAUSED THE BLOOD TO COME OUT OF THE BODY AND THE THING THAT CAUSED THE EMPLOYMENT TO FALL.

Someone aimed a gun and pulled the trigger. Then a bullet entered the body. To solve that problem one should first deal with the bullet and the damage it caused and then capture the shooter. That course of action seems a bit more logical than pushing the blood back in.  

In the case of employment we need to understand what caused the employment level to go down in the first place. Was it because firms decided in 2008 that it would be great fun to layoff a bunch of workers? Was it because workers decided that 2008 was a great time to take an extended holiday? Was it because we had a major drop-off in bridge construction? Was it because workers were paying too much tax into the social security system? I don’t think so.  Was it because we had a major financial collapse based on too much leverage generated by a housing and financial bubble? Hmmm – that sounds a little more plausible.

Cause and effect usually seem so obvious to us. If we drink too much JD at 2 am while dancing the boogaloo to the tunes of Jerry Lee Lewis we know what the result is going to be the next morning.  The solution is pretty simple. If we try to tweet while smoking a Marlboro, eating a double burger with lots of ketchup, and drinking an orange slurpy, then we might not be able to avoid that deer in the road. The solution is pretty obvious.

So why is it so hard to apply these same principles when it comes to our economic problems? I have a few guesses. First, members of our D party see economics as primarily a war between workers and owners. Their solution for just about everything is to emasculate rich owners and give the proceeds to poor workers. So if the employment level goes down the D thinks it is time to use whatever possible weapons you have to aid the worker. Second, members of our D party think that government is the answer to many of our problems and government spending is one way to create a better world. The list of possible good projects is as long as Pinocchio’s’ nose. Thus it is no surprise that we got the original stimulus packages, followed by calls for more stimulus, and now the President’s proposal for an infrastructure bank. Third, Rs get sucked into familiar issues relating to less government and simply have not shown any understanding of or real leadership when it comes to policy to address the financial crisis. Evidence is that the American Public – who will be ones voting in 2012 – show very little understanding of the most important financial issues. It was seen as a great victory, for example, when it was recently announced that unemployed persons will have yet another year of release from financial responsibility for the housing payments they owe on their property. It sounds like a humane policy for unemployed persons but it clearly flies in the face of a financial remedy. Note:
      Financial problems caused employment to worsen
·         Remediation of financial problems will cause employment to improve.

Now that’s not so hard. Is it?

Summary – There was nothing to panic about in the June employment report. The June report told us what we already know – it will take a while for the economy to recover and as it does it will experience ups and downs. Wild attempts to invigorate employment in the short-run or add billions to spending in the long-run are counterproductive. Doing nothing would be better. But even better would be to fashion policies to focus on the causes of the financial crisis. 

Tuesday, July 5, 2011

Maria, Tony, and the Debtside Story

As the deficit version of the West Side Story plays out in Washington I wanted to make sure I got my frog in the race. Right now there are two things stuck in my JD (I don’t know what a craw is or it would be stuck there.)

The first is this quote I got from after the President’s speech last week.
President Barack Obama cast his disagreements with Republicans in deficit negotiations as a struggle between the interests of hedge-fund managers and corporate jet owners against those of the elderly and college students as he pressed congressional leaders to accept tax increases.

The second has to do with a Congressional divide that would only take second place to the gang wars between the Jets and the Sharks. Who can forget the words, “When you’re a Jet you’re a Jet all the way from your first cigarette to your last dying day… When you’re a jet, you’re the swingin’est thing: Little boy you’re a man; little man you’re a king. Is it possible that Democrats or the Republics could be any stupid-er than these guys?

Keep in mind that the Westside Story is a musical. But apparently it took the death of Tony for Maria and the other idiots to realize that they had to change their habits – like stop hating and killing each other.

So let’s pursue this second point a bit. I will get back to the first one shortly. The Democrats stare into the camera with that beagle look and say that to be fair any solution to a huge and growing debt must involve tax increases. If the Rs will not cotton to major tax increases, then the Ds are going to take their balls home. The Rs look into a camera on another network which will remain nameless since Fox swears it is not a tool of the R party. The Rs look earnest and caring when they explain that an increase in taxes will utterly destroy the universe as well as the US economy.

Now back to the first point. Will someone please get President Obama off the golf course and explain to him that sometimes the interests of the elderly, college students, hedge-fund managers, and corporate jet owners coincide? EVERYTHING is not a gang war between the many groups that comprise our nice country. Maybe the tall guy on the basketball team makes more money than the short guy – but knocking 2 inches off the biggest guy and giving it to the shortest one is not really going to produce a winning record.

Why does the President, when given the microphone and the attention of the US public, have to grovel in this class-war crap? Why does he think he increases his popularity among voters when he plays the Jets/Sharks card? What matters for the poor, the young, the old and for Hollywood movie stars is that the US economy grows. While Keynesians and others might bicker about the best short-run macro models and policies, there is hardly any debate about the long-run model which says that three things cause growth – labor employed, capital employed, and productivity.

Enough about the President. Let’s get to the Rs and Ds. They just don’t get it. The Rs play to the Jets and the Ds to the Sharks. That’s it. End of story. I know the Rs and Ds have seen Westside Story and I know they know the ending. So why do they want Tony to die before everyone becomes friends and they live happily ever after? Can we not learn anything from musicals? I guess not (I learned a lot from Hair and from Buddy, but that’s a different topic for a later posting.)

If you are a good R or a passionate D you are ready to beat me with my own JD bottle. You just know you are right and the other guy is wrong. Davidson is a silly compromiser who just doesn’t get it. The R tells me that tax increases are just going to send the wrong message and before you know it, spending will resume its usual path and we will be back in this pickle again. The D tells me how unfair it is to keep helping the rich when there are so many people suffering. You know what – you are both right! But dudes (and dudesses) – you gotta put first things first.

You are playing with a wet firecracker. You don’t know when it is going to go off but if you keep playing with it – it is going to blow us all up! The Greeks were in the streets protesting austerity and many Americans will be on US avenues too. But finally the Greek government showed some real leadership – something that is sadly lacking in America. I am not going to quote deficit/debt numbers because you see them too often. But if you think the deficit/debt future looks bad now please understand that the scarey numbers you are seeing are already part of an optimistic scenario that assumes low interest rates and relatively strong economic growth. More reasonable estimates of future interest rates and GDP growth suggest that debt is even worse by multiples. We don’t seem much bothered by debt/GDP ratios of 100% but within a few years this number could exceed 150%. That’s pretty close to killing Tony.

So maybe we shouldn’t raise taxes. And maybe we shouldn’t reduce entitlements. But if our government doesn’t soon show the world that we have a plan to put our debt/deficits in order, we are going to be soon helping Maria find a new partner.  

And let me throw this out – a solution isn’t that hard to find. Taxing the rich and businesses right now is not a good idea. But that doesn’t mean we can’t legislate a plan to increase future tax revenue in the context of a major tax reform. In fact, a good deal of the tax revenue decreases we witnessed over the last two years was caused by the recession and will disappear as we grow. Recall that much of the spending increases were supposed to be temporary – designed to kick-start the economy. Well, the recession ended two years ago. Undoing those programs should not be called a spending decrease. It should be called keeping a promise. Entitlements should not be untouchable either. Too many level-headed people have shown that you can make relatively small changes to the major entitlement programs without hurting the old or the young too much.

This is all very doable. But it takes some real leaders who understand that the Jets/Sharks mentality is really stupid and self-defeating. Maybe when voters understand this, they will stop voting for these troublemakers and we can get on with solving some very challenging economic problems.