Tuesday, October 29, 2013

The IMF and the G20 Blame Game

Cartoon by Jim Gibson

Whether we need it or not the International Monetary Fund (IMF) publishes a global forecast twice a year. The October 2013 World Economic Outlook was recently announced with about as much fanfare as a rodeo in Ithaca, New York. The link to this several hundred page tome is http://www.imf.org/external/pubs/ft/weo/2013/02/. Luckily one can read what they call the front matter to get the main points. The Wall Street Journal did a nice summary on October 9, "IMF’s Pessimism on Global Growth Widens". Pretty graphs reveal the key points – as compared to last April, the IMF has a revised downward the expected future growth of the world economy. They also forecast an increase in GDP on the Uranus but their interplanetary accuracy is not quite up to Earth standards. With respect to Earth the biggest story line is the downward revision of future economic growth rates of the emerging and developing countries. The average expected future growth of advanced economies was unchanged from April – but the IMF is much more downbeat about short-term prospects of places like Brazil, Russia, India and China.

Why do I bother you with this? For one thing I needed a good reason to pour a cool JD. JD seems to go well with this activity and we all know the old saying that a JD a day keeps the doctor away. But I jest. The real reason I write about this is to gloat. On September 20 my blog was entitled The G20 Blame Game and in that blog my main point was that the emerging countries should quit pointing their fingers of blame at the US and start taking care of their own destinies. I know many of you think I make this stuff up between taking out the garbage and sharpening my dart skills – but I am always pleased to find out that REAL working economists agree with my stuff.

Oliver Blanchard, the IMF’s Chief Economist said, “Emerging markets should use the small window of time available to get their economic houses in order.” The small window is the time before the US Fed begins to taper monetary policy. With Janet Yellen as the new Fed chair that window could be longer than Blanchard believes. But let’s go along with the idea of a short window – what is Blanchard recommending?

The first thing he is not recommending for the emerging nations is more Keynesian policy. He seems to be suggesting that Keynesian expansion is what helped them get into their current mess when he says “the potential reversal of years of cheap cash exposed years of financial and economic weakness.”

So what do you do if you can’t simply open the fiscal and monetary spigots? While Blanchard would probably never utter the words “supply-side economic policies” it is hard to differentiate the IMF’s recommendations from a supply-side approach. I cherry-picked  some of the report’s main points…
  • Curbing potential economic expansion are competitive constraints, infrastructure bottlenecks, and slowing investments
  • China should rebalance away from exports to domestic consumption
  • India and Brazil should remove barriers to foreign investment
  • Countries with large budget deficits need to tighten
  • Turkey and other countries with high inflation rates must raise interest rates and put in more credible monetary policy
  • Emerging markets should let their currencies depreciate
  • Europe needs to work on a unified fiscal budget and a banking union
  • Japan must continue its economic restructuring
  • The Fed should not begin to taper this year but should be ready by 2014 and 
  • The US government must solve its budget stalemate

It is true that the IMF worries that US tapering could cause some negative overshooting in emerging markets – drawing precious funds away from those countries. Inasmuch the IMF agrees that these withdrawals should be offset with domestic monetary policy. But this is seen as a replacement for the missing money and not a return to expansionary monetary policy. The IMF is very clear that the world has had plenty of stimulus and now the challenge for most countries is to focus on competitiveness and making capitalism work better.

Tuesday, October 22, 2013

Inching Closer to a Homeless USA?

Cartoon by Jim Gibson

Now that we avoided one cliff in October we now have a little time to avoid another one in early 2014. Predictably what gets done will be decided by real and imagined descriptions of past and future government spending growth. During the last standoff we heard about the sequester and how it limited government growth. Some Democrats use that fact today to strengthen their case for more future spending and higher taxes. 

But the government’s own forecasts belie that interpretation of austerity and show a real cause for alarm coming from future federal spending. Lawrence Summers recently argued in the Wall Street Journal that national debt is a secondary issue but I argue here that a continuing debt explosion threatens to make us all homeless.

I wrote on October 8 about the national debt and how the CBO believes that under current budget law the US net debt will hover around 70% through 2023 – staying well above the pre-recession rate and historical norm of about 36% of GDP. The implication is that even with the spending constraint implied by the Budget control Act of 2011 and the sequester, we cannot make even a tiny dent in the swollen national debt. Guest Blogger Jerry Lynch followed up on October 13 with a similar story citing the gross national debt staying at about 100% of GDP. It is one thing for debt to rise temporarily in an emergency like the world recession of 2008/2009 but it is another thing to let it remain so high for another 15 years or so!

Today’s posting reinforces this discussion of debt by focusing on government expenditures. I do that because of the many distortions we are hearing from politicians who do not want face up to tough spending challenges. Some are pointing to the fact that the US government deficit and federal government expenditures fell in 2012 and 2013 and conclude that we have taken care of the government’s financial problems and can now get on with more spending and higher taxes. But just like the debt figures already cited, the spending data show that we are on our way to financial disaster. Okay – so you lost 2 pounds on your new popcorn diet – but if you are 100 pounds overweight this is no time to celebrate with an upside-down pineapple cake with Jack Daniels flavored icing.

It is true that government spending declined during fiscal year 2012 by $61 billion dollars and by $82 billion in fiscal year 2013. That’s a two-year total decline of $143 billion. But that is a small part of a bigger story.  Between 2007 and 2011 – government spending rose by a total of $870 billion dollars. In those four years, government spending rose from $2.7 trillion to about $3.6 trillion. That’s an increase of about 30%. If we account for the spending reductions in 2012 and 2013, we are left with an increase of government spending from 2007 to 2013 of $727 billion – meaning that since 2007 government grew by about 27%.With or without the recent reductions we are nowhere near to anything one might call restraint or austerity.  

Now let’s look at the future. Whatever gains might have been started in 2012 and 2013 they are over, finished. The CBO budget scenarios assume the continuation of the budget caps and so called restraint from the Act of 2011 – but notice they do little to overcome inertial government growth. The CBO estimates that with restraint, government spending will grow by $147 billion in 2014 alone. That is, in just one year the federal government will make up for all reductions in 2012 and 2013. The yearly increases following this $147 billion increase will be (again assuming spending caps in place):
            2015  $175 billion
            2016  $261 billion
            2017  $223 billion

Some 10 years after the US recession began and almost eight years after it ended, government spending will have gone from $2.7 trillion in 2007 to $4.3 trillion in 2017. Government spending will have increased by about $1.5 trillion or by 56%.

Governments swear to us that crisis spending is always temporary to get permission to go deep into debt. As soon as someone suggests that the bloat be reduced, they immediate call these requests unreasonable or worse.

Debt problems are real. They won’t go away by raising taxes. The more taxes we raise the more these fiends will spend. The really sad thing is that government has the capacity to do a lot of good. But doing this good becomes harder and harder when the country goes further and further into debt. We put ourselves in the worst jeopardy by not getting the financial crisis under control. What happens if we have another recession? What happens if terrorism requires more military and security spending? What happens if the Fed tapers and interest expense doubles or triples? What happens if Larry needs more JD?

Many people become homeless because they get themselves into debt and then an emergency strikes. What happens when a country goes into debt and suffers a similar crisis? The answer is not good. Don’t listen to Washington crying. Something has to be done about government spending. Even if the progress is gradual – something must be done. For every year we remain with high debt, the more we weaken our economy and open it up to risk of crisis. That is no way to run a country.

Tuesday, October 15, 2013

Debt Ceiling Redux

*Jerry Lynch has been an economics professor at Purdue for over 30 years.  He also served as Associate Dean and Interim Dean of the school in various past fits of insanity.  He has returned to teaching the core Macro Policy class in the MBA program and is pleased to have this blogging opportunity to spout off.

As of late October 11, 2013, nothing had yet occurred to solve the problem of the debt ceiling.  So hysterical is the rhetoric that one may think bumping into the debt ceiling comes around about as often as Haley’s Comet.  In fact, the government has raised the debt ceiling five times since 2001 typically without this much fanfare.   What started all this? Is it a new phenomenon? Why do we have a debt ceiling anyway?  Let’s look at the history and then think about the consequences to not allowing the debt ceiling to be raised next week.

The government raises tax revenue and spends money and there are three possible outcomes from this.  Tax revenue can equal spending and we have a balanced budget.  Tax revenue can exceed spending and we have a surplus. Or, tax revenue can be less than spending and we a deficit.  What does the government do when it has a deficit?  Up until recently my bet is that most people would have said the government prints money.  Not exactly.  There is not, thank God, a printing press in the basement of the Rayburn office building or in the Oval office.  While only the congress has the power to tax and spend, the Federal Reserve actually controls the money supply. So, if the government spends more than it takes in it sells bonds, borrows money.  What it borrows per year is the deficit and the past accumulation of borrowing is the debt.  There is not a deficit limit.  There is no legislation that states how much Congress can spend over its collection of taxes in a year.  There is, however, a debt limit.  Total federal debt has been limited since the Second Liberty Bond Act of 1917. The statutory limit was denominated in an actual dollar amount and given that government runs deficits nearly every year, it is no wonder we are constantly bumping against that limit.

When the debt ceiling was first established in 1917 it was $11.5 billion.  It has been raised 74 times since March 1962. The first time it was raised during the Reagan administration in 1981, it went just over $1 trillion.  The National Debt right now is just under $17 trillion.   It is difficult to find a source to say what the exact number of the debt ceiling is. Perhaps that is because some of the debt is exempt from the ceiling and the calculation is not all that easy.  The magic date seems to be October 17th.  The US will reach the maximum amount it can borrow and there will be no new bonds issued. Why are we facing this crisis? There are really two questions there.  The first is: why is there a debt ceiling and the second is, why have we waited so long to address the issue?

When Congress passed a debt ceiling back in 1917 it was trying to impose an external restraint on how much it could spend.  It seemed comforting to know that we would not borrow past a certain limit.  The party not in charge of the Congress can always point to reaching the debt ceiling as a sign of the profligate spending by the group in power. A number of times when the debt ceiling has been raised, it has been raised by a percentage of the existing debt as opposed to a strict number.  Who knows what will happen this time.  We have come to this crisis point in part because of a breakdown in civility in Washington and in part, because the debt has really grown in recent years.  As recently as 2007 the debt was under $10 trillion but more importantly, it was about 65% of GDP. The measure of the scale of the debt is not the absolute number, but its relative size to, say, GDP.  Now, it is bumping up against 100% of GDP and people have become alarmed.  Even though the deficit has fallen in recent years, the debt to GDP ratio continues to grow and that is what is sounding the alarm. We have waited this long to address the issue because Congress, like all people, prefer to kick the can down the road.  In this particular instance, Congress has become the Sebastian Janikowski[i] of can kickers and there are threats that we will let the government reach its limit and stop borrowing.  What will happen?

The big discussion seems to be about the US defaulting on its bond obligations.  In truth, that does not have to happen.  The US can roll over the existing debt it has without surpassing the ceiling and it can pay the interest on the debt.  That said, what could happen is not a pretty scenario. The US government spends about $3.5 trillion a year and brings in $2.7 trillion in tax revenue.  Thus, spending would have to be reduced by $800 billion in order to balance the budget and not have to spend based on issuing bonds.  Some might think that an $800 billion reduction in federal spending would be good.  Without debating the long term consequences, it would not be good in the short run.  In fact, it is such a large cut in spending that it would almost be impossible to carry out.  Even those who might think that an $800 billion reduction in spending would be good would complain as soon as their ox is getting gored.  However, the long term consequences of following our current path are not something we want to see either.

What will happen?  As loathe as I am to forecast, we will come up with some short term deal and may already have done so by the time you read this.  What one hopes this crisis brings about is a meaningful discussion of the size of government and how it should be financed.  There are many concerns about the debt, here is my largest.  Interest payments on the debt come from tax revenue and that is how it should be.  You don’t want to service your debt, whether you’re a country or a firm, by borrowing every time interest payment comes due.  So, interest payments should be made out of revenue which for the government means tax revenue.  How much of that tax revenue will go toward servicing the debt?  Net interest on the debt right now is about $330 billion per year or maybe 12% of tax revenue.   We are currently financing our debt with some of the lowest borrowing rates in history on Treasury bonds and bills.  However, as the debt to GDP ratio continues to rise, and once interest rates return to their historical levels, the interest cost to service the debt will rise.  No one knows exactly how high because we don’t know what will happen to interest rates.  Some sources predict a trebling of interest cost on the debt within the next three years. Of course tax revenue will grow over that time but we could easily be looking at 25% of tax revenue going just to service the debt.   As that happens, our ability to do the kinds of things we want to do with tax revenue is diminished.  If 25% of your income is going to pay the interest on your credit card debt, you have a reduced standard of living.  That is, I think, the biggest long term concern of the size of the debt relative to GDP.

Will we pass a temporary debt ceiling increase and kick this can down the road?  Yes.  Is the debt ceiling an artifice to allow for these discussions to move into crisis mode? Yes.  But, do we need to address the long term implications of the debt in a calm and meaningful way sometime soon? Absolutely yes.  Unfortunately, Congress acts too much like a freshman with a term paper. We won’t get back to it until the next crisis comes to a theatre near you.

[i] NFL kicker – known as the Polish Cannon. Larry Davidson will be upset I used this analogy instead of him as he kicked field goals in high school and college football.

Tuesday, October 8, 2013

An Easy Budget Compromise

Cartoon by Jim Gibson

The President won’t talk to the Republicans because voters elected him to do his thing. Republicans retort that Nancy Pelosi famously said that we would not know much about Obamacare until it was legislated. Well it was legislated and as Pogo once said, “We are confronted with insurmountable opportunities.”

Here’s my take on this current fiscal madness. There are some real economic and political problems coming down the pike in the next 10 years. Neither party is going to like them. They really ought to be doing something about them. Playing Hatfields & McCoys is entertaining but it won’t help. Sorry to say this but one part of what is wrong about the next 10 years is Obamacare or at least our desire to quickly be like other grown up countries that have national healthcare. But the problem is broader than Obamcare.

As usual these guys take us to the brink so there are presently no good choices. But it seems pretty logical that both sides could agree on a truce that would stall things until January 1 while they focus their attention on what they could reasonably do about our budgeting problems. That would, of course, include Obamacare. Some of you call me Laughing Larry (or LL for short) because I am sometimes too optimistic about things and by things I mean politicians. As usual I will use this space to lay out why these guys need to get focused on the right issues. But do I really think they will listen to LL? Of course not. But I have a choice. I can walk the dog or I can hide away in my basement with a half-gallon jug of JD pretending to be solving national problems.

The case is pretty compelling. Both sides have much to gain through some compromises. After all mutual gain is the basis of compromise, right? So below I use some data published by the Congressional Budget Office in Updated Budget Projections: Fiscal Years 2013 to 2023 http://www.cbo.gov/publication/44172

Republicans often stand up for smaller government deficits and debts. The federal budget deficit as a share of GDP will decline as we approach 2023. But hold on. In 2007 the deficit as a percent of GDP was about 1.2%. It went to 10.1% in 2009 but declined to 4% in 2013. It is expected to remain as high as 3.5% of GDP in 2023. The average GDP during the next 10 years will be about $21 trillion so 3.5% of a big number is also a big number!

Keep in mind that every year there is a deficit, it must be funded with brand spanking new government bonds – bonds that add to the national debt. 

Speaking of the national debt – the net debt in 2007 before the crisis was a reasonable 36%. It rose to 75% of GDP in 2013 and is supposed to top out at 76% next year. It is expected by the CBO to remain at 74% in 2023. So the nation’s debt doubled and the best we can do is maintain that doubling over the next 10 years? Seems to me we have it all backward. Why aren’t we trying to move it back to 36%?  Please do not tell me that these elevated deficits and debts will not have a negative impact on long-term economic growth and employment. Business as is in the government is not good business.

The Democrats won’t like the future either because it means that government interest expense, Social Security, and healthcare will eat up an increasing share of government expenditures. Thus both mandatory and discretionary programs will command much smaller shares of the economy in the future. See the table below. There you will see how healthcare, pensions, and interest expense will gobble up an additional 4% of GDP and that the CBO expects much of this will come out of the hides of other mandatory and discretionary programs.

Neither side has much wiggle room – because taxes and spending will be at all-time highs as a share of the economy in 2023. Tax revenues will have risen from 19.1% of the economy before the recession to 22.6% in 2023. Government spending will have gone from 17.9% to 21%. In short, government will be bigger in 2023 – not just absolutely but relative to the size of the economy. This will make it even harder to afford better government programs – military or otherwise.

So while the deficit might fall for a while, everything else really stinks – future debt, interest expense, growth and the flexibility of government to help people who are not sick or old.

My conclusion is that they ought to pay attention to the costs of Obamacare but they really need to get on with the task of changing all the budget lines. Neither side seems willing to do that…at least not yet.

Projected Spending for Major Budget Categories
(Percent of gross domestic product)

     2012       2023        Dif
Major Healthcare                         4.7           6.1        1.4
Social Security                              4.9           5.5        0.6
Net Interest                                  1.4           3.2        1.8
Other Mandatory                          3.5          2.4       -0.9
Defense Discretionary                  4.3          2.7       -1.6
Non-Defense Discretionary          4.0          2.7       -1.3

Tuesday, October 1, 2013

What is a Healthy Economy?

Cartoon by Jim Gibson

Your tweenage daughter wants to know when she can start dating guys with beards and motorcycles. Your first reaction is to tell her she can have her way when hell freezes over. But you are smarter than that. You tell her she is free to date whomever she pleases once she shows more maturity. Satisfied she goes back to texting her best friend about when they will meet at the mall.

This approach has great merit. What does it mean to show more maturity? Does it mean that she makes her bed every morning or does it mean that she has saved enough money for retirement? Clearly, any time she comes to you with another reached milestone in maturity, you can tell her she is still deficient and cannot yet date guys with beards and motorcycles.

Where is this heading? Has LSD been into the JD this morning? It sure sounds like it. My point is that this is exactly how the FED is treating us. Mr. Bernanke tells us that the economy is not mature enough yet to let it go out alone without a chaperone (Mr. Bernanke).  But Ben, when will we be mature enough to stand on our own? The answer is – when Ben says you can stand alone. Be good and go to the mall and spend a lot of money. Ask Ben again tomorrow.

When will the economy be strong enough for the Fed to taper? When will it be strong enough for the Fed to remove all that unwanted and unneeded monetary flab from the system?

Macro does not make this question easy to answer because there are so many ways to judge the present and expected future health of an economy. Most of us think the unemployment rate is a great macro indicator but we also know that the unemployment rate can go lower simply because more people give up looking for work. So it is possible that the unemployment rate could go to 6.9% and the Fed would still judge the economy too weak to walk without a cane.

So maybe if the unemployment rate was falling AND employment was growing, that would be good evidence of strength? But what if most of the new jobs were low-wage and/or part-time? What if most of the jobs were in occupations featuring pole dancing? 

What if employment was growing while events abroad portended a weakened China, Brazil, Canada or parts of Europe? What if those and other countries actively depreciate their currencies against the dollar? Wouldn’t we worry about exports and the President’s goal to double exports as our engine of growth and stability?

Or perhaps employment and unemployment are both improving but continued ambiguity about regulation in housing and financial markets leaves housing demand and supply weak. With housing at present depressed levels it would be hard to conclude that the US economy was out of the woods. What if interest rates start rising as employment improves? Won’t we worry about another housing crash?

You should be getting my point. If not, try a little more Soju. The Fed says the economy needs to be out of the woods but there always are and there always will be conflicting signals in the US economy. Business investment could remain weak for quite a while. The consumer has not exactly rebounded. So what really matters is not so much this excuse about the strength of the economy but rather the Fed’s intent.

This might sound blasphemous but whether it is Bernanke or Yellen, the truth is that we have two popular leaders who will always have a tendency to see weakness in the economy and worse yet – will not cherish the long fight for Fed independence and credibility. Without an independent and credible Fed we might as well let the Department of the Treasury spew money from helicopters as the government deems necessary. And of course, that will lead us sooner or later to catastrophe.

Surely I exaggerate? I don’t think so. Government debt is in outer space and on a trajectory to reach the sun. Yet the government has no plan to constrain our nation’s debt. Notice that the current congressional debate has almost nothing to do with future debt issues.We have known since about 1964 that the baby boom generation would bust the budget today and have had almost 60 years to deal with that – yet we are not much better off in 2013 than we were when I was 18 years old. 

What does Congress and national debt have to do with the Fed? This government debt has to be sold each year. The Treasury has been selling roughly a trillion dollars of debt each year. While the economic recovery is reducing that amount, the respite is temporary and the government will continue selling a s---load of debt each year. Someone has to buy it. That’s a lot of US bonds to soak up. To make this avalanche of bonds desirable the markets would ordinarily need to raise interest rates on the debt. While this is wonderful for the bondholder we all know this would be bad for the economy.

So the Fed plows in with its capacity to create infinite waves of money and buys government bonds. A trillion dollars for bonds? No problem. Ben just writes a check. One does not need to be conspiratorial to believe Obama “makes” Bernanke buy those bonds – one can simply believe the Fed is trying to help the economy overcome this giant wake of the government’s incessant and huge demands for credit. Thus the Fed acts “as if” it were a part of the liberal democratic administration.

In doing so, the Fed abdicates its independence and along with that goes its credibility and ability to function. You know why credibility is important. Without credibility your threats as a parent go ignored. Honey – don’t put that screwdriver in the electrical outlet or I will put you in timeout with Dr. Phil. If the kid never gets put in timeout – the chances are she will ignore your directions. Likewise if the Fed puts in a policy designed to reduce interest rates and we all know that the Fed never acts against rising inflation – then it is likely that at some point a policy designed to reduce rates and stimulate the economy will fail. Future attempts to reduce interest rates will raise inflation expectations and will raise, not lower, interest rates. The Fed at that point becomes largely redundant.

The Fed needs to be independent. The Fed needs credibility. The Fed needs to point its boney fingers and forcefully lecture the government about proper fiscal finance. The Fed has to admit that the economy is ready to walk if not run. They will always find some data or some excuse to postpone proper monetary policy so long as they are in denial about proper central banking and its limits in solving all of man’s problems. The Fed can wait but in doing so it risks a jump from the frying pan into a volcano!