Tuesday, September 25, 2012

Oliver, Little Red Riding Hood, and Two Rib-eye Steaks

I know there are many of you out there who awaken each Tuesday with great hope and anticipation that this will be the week when you get an email from Larry that says – sorry folks nothing to write about. Take the week off.  Many of you are secretly wishing that Dupuytren’s contracture will finally run its course and turn my digits into useless and immobile paper weights. And I keep wondering when that week will come too. I have now been retired for 2.5 glorious years and have apparently bothered you 160 times. Each week I wonder what will set me off like 1000 liberal Democrats on Facebook after a Romney gaffe. I of course forgive them and hope they respond in kind.

This week the arousal came when I read an article by Martin Wolf in the Financial Times September 18, 2012 “Bernanke Makes a Historical Choice”. Surprisingly despite the historical nature of Bernanke’s announcement and the promise to keep interest rates low and to keep infusing the economy with money until Hell freezes over or until the unemployment rates comes down to levels acceptable to the last unemployed person – Martin Wolf believes the Fed nor the government has done enough to revive a deficiency of spending in the economy. Not doing enough of course implies that the Fed and the government should be doing more. He quotes a paper given at the recent prestigious conference at Jackson Hole, Wyoming that recommends a policy leading to a 45% increase in national spending through 2016. Only Usain Bolt is faster than that!

Wolf reminds me of a song in the award winning musical Caddy Shack. Just kidding – the music in Caddy Shack was nowhere near as interesting as the scores of Oliver. Let’s face it making a musical out of a Dickens novel is no easy thing.  I am not sure of the name of the song but I do recall when the poor orphan has the gall to ask for more gruel. Clearly in that orphanage asking for more food or a second helping was out of the question. Like the orphan, Wolf wants more – he wants more money. I’d be willing to give him more gruel.

In the case of monetary policy – it seems to me that Wolf is wrong on two scores. First, the source of the problem of the US economy is not deficient demand. And second, even if it was the source, pouring even more money on the problem is not going to help. It reminds me of someone suggesting that right after you ate two really large rib-eye steaks (or maybe a giant porterhouse for two) would be a great time to ingest a third steak. After all, the price is low, so you should go ahead and order and eat the third steak. And maybe a fourth too.

Little Red Riding Hood was a cute little girl who was almost duped by the wolf in that children’s story. Do you know of any children’s stories where the little girl, her grandmother and a lumberjack kill a wolf, splay it, and then fill the open body cavity with stones? That seems a little extreme to me and I am not recommending such an action for Martin Wolf. But I do wish he would stop harassing us with his evil and misleading stories.

Let’s get back to the coordinated and more aggressive monetary and fiscal stimulus that would please Wolf in 2013. While some of you choke up just hearing me say that, there is widespread and strong support for such policies. Larry Summers published a piece in the FT giving Great Britain the same advice. Last week Wolfgang Munchau expressed his desire for more stimulus in Europe. These are influential people. They keep hitting the same themes. More is better. More spending is better. Full speed ahead. Man the torpedos.

Wolf is especially good at creating straw men. He defends opening the monetary spigots even wider by pointing out that the critics have been wrong about hyperinflation. Wolf looks around and says – I see no hyperinflation. So the critics are wrong. What a bunch of hooey. While critics of liberal monetary policies often worry about the impact of too much money on prices – most of us have been pretty specific in our arguments about the current monetary failures. The money multiplier simply doesn’t work today. You can jam reserves into the system like pancakes at a church social, but you can’t be sure it will turn sinners into saints. All those trillions of dollars of money the Fed injected are either being held in safe places by uncertain financial institutions or it is leaking abroad. When Bernanke injects another trillion it isn’t going to change a thing. A quick look at the statistics shows some mind bending facts. One wonders how much more money the economy wants or needs. According to the St. Louis Fed’s Monetary Trends – bank reserves increased from $95 billion in 2007 to about $1.6 trillion in 2011. If you are bad with numbers – a 10-fold increase would have increased bank reserves to a little less than $1 trillion. So we are talking about a 16-fold increase. Imagine if my weight increased by 16-fold. I would now be a svelte 3,200 pounds. That’s a lot of folds in four years. How many more folds are going to make a difference to Mr. Wolf? How about 32-fold? Will that make him sleep better at night?

The thing that these liberal wolves forget is confidence and cause and effect. Injecting more money now just confirms to people that they should be worried as hell. After 16 eye operations by the same surgeon you sort of wonder if he will fix your problem after five more tries. Injecting money now does absolutely nothing to resolve the problems that plague the economy. Surely more money caused a small depreciation of the dollar but will that really paper over all the reasons foreigners prefer to buy their goods elsewhere?. Surely more money does little to reduce US taste for foreign goods. Surely more money does nothing to help restore the value of household saving so families will be able to spend confidently again. Surely money does nothing to improve social problems or make workers more educated or productive.

Wolf is very clear when he says he prefers the risk of too much stimulus to too little. But then he uses the loaded term deflation. He prefers the risk of inflation over the risk of deflation. That is a fair statement but again it is a red herring (no offense meant to blue mackerel). But really – who is forecasting deflation for the US economy? The US economy might be struggling but the last time I checked most of the inflation measures were coming in somewhere close to about 2% per year. As I said above, I doubt we will see too much inflation either but that’s not the issue here. The issue is that a monetary stimulus in 2012 and 2013 has no rationale. There is no cause and effect to support it. He uses no cause and effect in his articles. People like Wolf are somehow wedded to an ideology that might have had its place somewhere at some time – but the place is not the US and the time is not now. I wish Mr. Wolf would take off his grandmother costume before he ends up with a load of bricks in his gut. When Little Red Riding Hood figures all this out – the Wolf is going to be in a lot of trouble.

Tuesday, September 18, 2012

Let's Not Compromise

In the USA, we find ourselves in a very bad place. The economy is not improving and if anything after several years of slow growth it appears than we are slowing further. That bodes ill for all of us but it definitely doesn’t help families who need income just to survive. While the unemployment rate has not increased much lately it appears that the reason it has been stable is because people have stopped looking for work. I could go on. So could you. Point – we are in a bad place.

One reason we are staying in this bad place is that our politicians refuse to do anything constructive. Imagine an athletic team that gets worse and worse yet the owners and coaches do nothing. That is unspeakable. Take the Indianapolis Colts as an example. They had a very bad year last year and promise to have another tough season this year. So imagine you are in a meeting and one executive says – we need to build the defense. Another Colt executive shouts – hell no. We need more points. We need to build the offense. I apologize to my friends from other countries for using American football as my example but it would be laughable if I talked about rugby strategy!  I think you get my drift. So each executive gets others to be on his side. Pretty soon nothing gets done. The Os are solidly against any move to shore up the defense. The Ds shout down any idea to hire a new running back.

Pretty stupid eh. It wouldn’t happen since there is a lot of pride and money involved in professional football. Is there no such pride or money involved with the US economy?
The Democrats and Republicans get a free ticket from most of us to behave this way. Someone suggests we decrease spending on Social Security and Rs are accused of a heinous crime only exceeded by blood sucking. Another politician proposes raising a tax on a rich guy and the Rs scream of socialism. Hang on to your tutus folks. Then some bloke from another planet suggests they compromise. COMPROMISE! Give in to those bloody bastards – no way Jose. Both Ds and Rs come unglued. You want us to give up our ideals? Do you want us to kick the can down the road? Do you want us to agree to vote for something that will embarrass us in the future?

In short COMPROMISE has become the latest 4-letter word. While I did learn to broadcast a full contingent of 4-letter words when in the US Air Force in the 1850s, my mother and my dear Betty would prefer I choose more acceptable vocabulary. So here and now I am declaring that I am totally against a COMPROMISE. There will be no COMPROMISES here. COMPROMISE is a dirty word.

So where does that leave us? Ds and Rs and not going to do anything and our economy is getting worse and worse. With or without falling off a fiscal cliff a do-nothing government leaves our country in a very bad place. Our football Os and Ds are not going to do anything so our team is going to get worse and worse. But alas, our team management is smarter than our national government. Our football executives will create a list of things they can do to arrest the decline of the team. They could avoid any discussions about building a better offense or defense yet together decide which positions are the weakest. So maybe they need a new center who can block. Perhaps a defensive end could put some pressure on the opposition passer. A better kicker could add some points. I’d vote for several new cheerleaders but only in a secret ballot.

Why can’t our politicians do a similar thing? Let’s not COMPROMISE but we could bring together representatives from both parties for the purpose of making a list of the biggest problems that need some remediation. I am not so innocent or stupid to suppose that these politicians would leave their guns and their ideologies at the door – but wouldn’t it be interesting (and refreshing) if a bipartisan group could simply agree to focus on what they deemed to be the most damaging problems. Forget a comprehensive solution – just take this first baby step and list the major problems. 

This approach is no different than one used by mental health professionals who tell an emotionally ill person to forget about becoming a perfect person. The first step is to do one thing towards being a better person. Maybe today you don’t scream at your loving husband when he leaves his towel, underware, and empty shaving cream can on the bathroom floor.

Now where was I? Okay – we have these emotionally unbalanced representatives of our government in one room with a mission to find a few things that might start the country moving towards better economic and emotional health. While you and I might not agree on every item – I don’t think that this is brain science.  We could come up with a list, couldn’t we? Let’s imagine that you are getting paid the salary and benefits and have the security of a senator – is it really asking so much to come up with this stupid little list?

My list would have some of these obvious national problems – education that doesn’t provide adequate backgrounds for future success in life and in business; in lieu of slow economic growth tax revenues that remain deficient; given deficient tax revenues a growth of government spending that cannot be financed without credit rating downgrades; bank and non-bank institutions that are burdened with too many non-performing loans and other bad assets; too many under-water households; a huge cloud of uncertainty hanging over small and other businesses; a tendency for the public and the government to use too much credit.  

Okay – so your list might be different. Wouldn’t it be super cool if people at this meeting could find just one of these things to work on? Wouldn’t it be better to have at least one good thing going for us rather than none? Okay one probably isn’t enough but clearly they might be able to find a few worth working on. If they found one then maybe that would set the stage for two!

Some of you might say NO. You don’t think that having a few of these things accomplished is worth it. It isn’t enough. It is kicking the can down the road. You want to hold out for a time when your good guys win. But consider this. You might not win at all. Then what will you get? Or you might win but with a narrow enough edge that you are stuck with no real mandate and nothing accomplished for another four years. Or maybe you do win big. Maybe you do get to legislate an ideologically comprehensive set of solutions. That sounds good but how many times has one party done that and kept it going? Not many. It seems to me the most probable outcome is the one we usually get -- one where we do not have a constant majority. One in which we don’t get everything we want. One in which policies are proposed that are not our favorites but have some chance of reducing our problems.

I am not ready to Compromise – but I am ready to attack our problems. In a few years the Indianapolis Colts will again be a competitive team. I wish I could say the same for the United States of America. Starting with a list of important problems would be a start. Such an accomplishment might lead to uncontrollable fits of hysterical optimism that leads these folks to finding a few solutions to these problems. I guess we will never know until they take the first step. 

Tuesday, September 11, 2012


The US Federal Reserve used to be like an elephant. It had one trunk and with that one trunk it could accomplish a lot. Of course, it couldn’t play the viola but then again who really wants an elephant sitting in an orchestra pit? Now the Fed is more like an octopus – not to be confused with Pussy Riot – with a bunch of arms. Despite having eight arms markets are not convinced this is any more useful than one trunk.

This post is all about monetary policy, moral hazard, and emasculation. The idea for this came from my reading an incredible book called In Fed We Trust by David Wessel. Wessel documents with painstaking and interesting detail the progression of the Fed’s powers between 2007 and today. I knew all that was going on in a general sense but to read the unfolding story it really floors you. It also gives us some insight into the motivations, ambitions, and personalities of the key players – Greenspan, Paulson, Bernanke, Geithner, and others.

There is a lot in the book and I highly recommend it but I try here to extract a few ideas. This is always dangerous and I rely on my faithful followers to let me know if I have misread the author. One key takeaway for me is that Fed Chairman Bernanke did not want to repeat the mistakes the Fed made in the Great Depression. Bernanke believes strongly that the Fed should play the lender of last resort role. Most people would not fault him for this. Whether it was the original Bear-Stearns  or AIG bailouts or the lack of one for Lehman, the over-riding principle was to calm the markets and provide enough liquidity and financial support to prevent financial spillovers from institution to institution.  It is possible that it would have been okay to let any one of these financial giants fail. But it was Bernanke’s decision that the fallout from each failure could bring down the whole system.

Along these lines one might say that the Fed was providing liquidity or general financial support. Another way is to say it was supplying confidence – confidence that one’s money and one’s financial assets would have some value in the coming day.  The broader environment found a federal government that was incapable of either discerning the problems or acting on them and it soon became the province of the Fed to be central bank, legislative branch, and executive branch.  Since the Fed is not elected or representative in any real sense, a concern is whether or not it should have acquired all these functions of government. Perhaps next year it will replace the Supreme Court. Why not? It is doing everything else.

You retort – Larry there you go again. Put down the JD and think rationally. And I would retort, read Wessel and tell me that the Fed has not taken over everything from greeting the diners to washing the dishes.  When I teach macro or monetary economics I have a lecture about the tools of the Fed. In the past I joked that the Fed was like a one-armed juggler – having one arm and trying to keep three balls in the air – output, inflation, and employment (and maybe more). When you have only one arm it is hard to do all that. That one tool used to be its ability to inject or withdraw money from the system via the discount window or open market operations. We say the Fed increases its balance sheet when it prints up money and uses it to buy outstanding government bills. It cannot buy these government securities directly from the government but it can legally enter into financial markets and buy them from existing holders. Stick money in the system when it needs more. Take money out of the system when the economy needs less. That’s pretty simple stuff.

So what has changed? Much of what has changed is called quantitative easing. With QE the Fed is no longer concerned with this process of adding money into the banking system. With QE the Fed is bordering on financial and fiscal policy by buying up very specific assets. It isn’t trying to liquefy the economy. Recent statements by the European Central Bank show it is planning to do the same – buying Spanish and Italian bonds which injects money into the system and then use other tools to withdraw the money or liquidity that would be added. Thus the ECB would be involved in a fiscal action – helping Spain and Italy – while neutralizing any impacts on the supply of money in Europe.

The Fed and the ECB are trying to resolve problems in specific sectors of the economy. One day the Fed buys distressed mortgages if mortgage companies are having problems. Another day they help out money market funds. A couple days later they pump money into a specific bank or other financial company or insurance company that is not able to meet its obligations. On another day they buy equities of an automobile company to protect auto workers’ jobs and pensions.  On Sunday if the till is short a few bucks they chip into the plate at the First Buddhist Temple of Bloomington. Okay, I jest on that one. But joke or not – the Fed has established a precedent – if Congress cannot act then the Fed will come to the rescue of any financially significant company or institution. We don’t need to go through that nasty process of making laws to solve economic problems. We just phone up the FED and explain that the world as we know it will crumble if the Fed does not buy shares in our local Childcare Center.

I think I am shouting. Plunk Plunk. I just freshened my JD with a couple of ice cubes. Ah that’s better. Now where was I?

One trunk or an octopus? Is this good or bad? Let’s start with the good part. It took the Fed a year or so after the housing crisis unfolded but when they did catch on to the full risks, they jumped in with both feet (or eight arms). They decided that doing nothing or just using traditional tools was not enough to stop a global catastrophe. One can disagree with their assessment or not but they did act and at least so far we had no worse than a long global recession. In the US the recession lasted only two years though the recovery has been slow and painful. But my point is that we will never fully know what might have happened if the Fed had stuck to its one tool policy. Inasmuch let’s give the Fed a gold star.

What can be wrong about this approach? Where do the future problems lie?

First and foremost is the issue of moral hazard. Moral hazard exists when an unintended result has an adverse moral effect that undermines your original intent. You pay your baby sitter a very high hourly rate so that she will take care of your darling little perfect child. You pay so much that the sitter sneaks out of the house and goes to a local bar and drinks Soju until five minutes before you get home. In the case of the Fed it is no accident that as soon as the word got out that the Fed was helping out, the line of despondent banking CEOs in front of the Fed door was longer than the queue at the unemployment office. It’s like handicap parking stickers. There are so many people claiming to be handicapped today that people with serious disabilities can’t find a place to park. The moral hazard the Fed created suggests that in the future, whenever things start to go downhill it will go downhill that much faster because claimants will compete to be first in line for a handout. All they have to do is make the case that they are systematically important and the Fed will look like it just saw Vlad the Impaler and start handing out money like the Mayor of Chicago at a Mafia convention.

The second worrisome future factor is that the basis of any current Fed success is exactly what limits its future success. What made the Fed successful is that the public believed the situation was dire and that the Fed’s intervention would work. As 2008 and 2009 unfolded there was much unknown and much to fear. The Fed really calmed the markets. But in 2012 or 2013 the situation is much different. For one thing much more is now known. For another we are not sure that the Fed has the secret combination. Thus – what do we learn when we hear that the Fed is about to make another major policy move to support the economy or some part of the economy? It tells us two things. First it tells us that things are much worse than we previously thought. Second, it may have a very negative impact on expectations and confidence. This more or less guarantees that the Fed policy will have little to no effect and raises the risk that our lack of confidence will show up in less employment, more selling of assets that reduce prices of houses stocks, and bonds, and a pimple outbreak among the under-40 set.

Third, the problem with these interventions is that they do not address the sources of our problems. Recall that the housing and stock market bubbles that kicked off this mess were born of TOO MUCH spending and borrowing. Notice that the Fed’s actions generally support MORE spending and borrowing. It is okay to give drug addicts methadone as they deal with withdrawal challenges. But at some point you have to move from that stage to one where no drugs are taken. The longer you stretch out the first stage the more you prevent or retard the eventual remedy. So far the Fed is still so worried about a financial collapse that it is not willing to get us off the drugs.  Notice that we have been in this phase for five years. When will the Fed start backing away from this phase? They were a whole year or more late in defining the crisis in 2009. What if they are a year late in knowing the worst is over? Once you become an all-powerful octopus for too long is it possible to become a humble elephant again? Only time will tell. Only then will we get on to the business of treating the problems that cause our economic malaise.

Tuesday, September 4, 2012


My last post on Millionaires and Billionaires made me realize that there are other loaded terms that get abused by politicians and ideologues. Others that come to mind are trickle-down, socialists, entitlements, etc. Each of these words has an objective meaning but they also stand-in for 4-letter words used to provoke and injure. So I thought I would continue this line of thinking by concentrating on entitlements this time.

Let’s begin with a definition. Wikipedia defines 'entitlement' as "... a guarantee of access to benefits because of rights, or by agreement through law." I like that definition – it is general. I signed a lease agreement entitling the landlord to a monthly payment. I am entitled to various things including a toilet that functions. We enter into explicit and implicit contracts all the time.  I pay taxes to the City of Bloomington and feel entitled to some degree of police and fire protection.

I see that I am putting some of you to sleep so let’s move on to a discussion of thermodynamics. Just kidding. While the definition of the word entitlement is pretty boring it gets a lot more heated when we start using it as a curse word. You are a lousy entitlement. You are dumber than two entitlements. No, that's not what I mean either. Somewhere along the line we used to classify government spending as expenditures on goods, services, and transfers. A government transfer is defined as a payment from the government’s budget to an individual. The word transfer literally meant the government was not paying for a good (Boeing aircraft) or a service (a teacher provides a service of education). Instead it was transferring money to an individual because a law provided that persons should receive money from the government. Many of these transfers were in the nature of welfare legislation which provided that people meeting eligibility requirements of the laws would receive payments from the government because they were old, sick, poor, etc.

Some people interpret the word transfer payment as a transfer of money from the rich to the poor. But that is not the real meaning. For example, any time the government pays for a good or a service, we don’t call that a transfer because we are taking money from the rich (or anyone else) and giving it to Boeing or Larry’s Wonderful Consulting Company. So why would you call it a transfer when the government took money from some people and gave it to the poor, old, and sick. All government spending is the same in the sense that tax payers are asked to give up money so it can go to people who provide goods and services and to people who are eligible for government assistance.

Notice that all this government spending is guided by the legislated laws of the land which presumably are consistent with the Constitution. While you might not agree with government spending on any particular program no one type of spending is any less legitimate than another. So maybe you don’t like defense spending. Or maybe you are very much against your local government paying a consultant to estimate the economic impact of owl habitats. You might think that the government pays poor people too much money. Whatever, if you don’t like it you can vote for people who will make legislation that is more compatible with your views. Until that time, it is what it is.

Still awake? Sorry. Do some pushups and drink a Cass. Maybe that will help.

Somehow the above terminology got sidetracked. Somehow we started using the word entitlement. Notice that in the strict sense of the definition, this is not a bad word to use for any kind of government spending. The strict sense of the word implies that legislation requires responsibilities of the parties. In the case of government spending a defense bill approves money to Boeing. Another bill allocates funding be spent on various service providers. Another bill sets funding for Medicare. These bills create an entitlement just like a lease creates an entitlement. There are good leases and bad leases. There are good bills and bad bills. But notice that citizens are entitled to what the bills support. To say that spending on Medicare is an entitlement means absolutely nothing. Spending on battleships, office machines, soldiers, policemen, teachers, poverty and social security are all entitlements.

So how did we get from there to here? Congressmen shout about entitlements as if they were the expenses of government employees on lavish hotels, illegal drugs and prostitutes. Entitlement has become the latest curse word to throw at liberals. Just like millionaires and billionaires, throwing out these words is meant to denigrate a group of people. It stereotypes and misleads. Millionaires and billionaires is often meant to indicate that high income high wealth people don’t do their fair share for the country. Entitlement conjures up an image of laggards who demand excessive support from the government to not have to work or be responsible citizens.

My liberal friends hated what I said last week because they felt I was being unfair to them. Sure they want millionaires and billionaires to pay more taxes but my liberal friends don’t use these words in the hateful manner in which I alleged last week. But for every one of you there is another Democrat who intends the worst stereotype. This week my conservative friends will be howling mad. They don’t have this awful image of people who receive entitlements – they will explain they are just saying that the current laws don’t serve their ends. But for every one of you, there is a Republican who holds and expresses these negative stereotypes of people who receive government transfer payments.

Thanks to a good retirement system and personal saving I am both a millionaire and a receiver of entitlements. So I get personally offended when I hear people use those words in obvious negative tones. I started working at the age of 18 and have been paying into the Social Security and Medicare systems ever since then. I don’t feel entitled to anything except in the same way I feel entitled to a good toilet. The law says that by virtue of reaching an old age, by making those payments for nearly 50 years and having to pee 12 times a night I should receive these government expenditures. I personally don’t give a hoot about moral debates that might argue whether or not I am entitled to these payments. I am entitled because the law says I am entitled. That’s all there is to it. If a hobo is similarly entitled to a rent subsidy, a food coupon, or an outright payment, so be it. If the law says it, then they are entitled.

So what am I saying? I am saying what I say over and over. This use of colorful stereotypical words and phrases is like yelling unkind names at the basketball team that just beat you. Maybe it makes you feel better but the truth is what you need to do is huddle with the coach and figure out why you lost and come up with a better strategy for winning the next game. Calling names is not only useless but it might actually harm you by making the other guys want to beat you even more. You Democrats please stop talking about millionaires and billionaires. You Republicans stop moaning about entitlements. What you both want is relief from this horrible economic malaise. The only way to accomplish that is being realistic, open and objective about the source of our current problems and work to create majorities that will support programs that directly create remediation. Pointing fingers and demonizing the rich or poor just ain’t going to cut it.