Tuesday, February 23, 2016

Should Obama Nominate a New Supreme Court Justice?

When a really big controversy hits I usually like to give it a month or two to see where things settle. But for this one I couldn’t wait. This one is a beauty.

I watched TV news and saw two parties talking past each other. The Democrats were saying that of course the President should do his Constitutional duty and nominate a replacement for Judge Scalia. Republicans were saying that they have the power in the Senate and would definitely turn down an Obama appointee or simply won’t go to the trouble of acting since it is a fait accompli.

Instead of focusing on the obvious story talking heads have already wasted enough hours to write the definitive almanac on love. Experts continue to discuss and debate the meaning of the remaining months of Obama’s time in office. They debated if he is a lame duck or not. They went on endlessly about the difference between a vote and not having a vote. They talked about Senator Schumer and what he said in 2007 compared to what he said last week. We have heard people analyze court appointees who were denied hearings in the past. Then there is the issue of whether or not today's voters should determine the choice. 

All that discussion is juicy but meaningless for today’s question. What no one seems to want to say is the obvious – we have a President and a majority party that are driven by ideology. Hillary was saying that even if President Obama nominated a moderate and reasonable judge – those darned Republicans would not give her a hearing. But folks – let’s be realistic. Is there a snowball’s chance in Hell that he would nominate such a person? Obama has publicly hated many of the decisions of the current Supreme Court. Remember Citizens United? That case is always and everywhere lamented by Democrats who would love the chance to have it overturned. Obama is being sued by groups who want to overturn many of his presidential directives as well as his prize legislation, Obamacare. Are you telling me that Obama would nominate someone who would threaten liberal progressive values? 

Obama will nominate a justice who will turn the tide of opinion on the Supreme Court. This new justice will allow the liberals on the court to have their sway and by all means the new court will get many chances to support Obama and to tear apart anything those hated Republicans want done  or changed.

So what are good Republicans to do? Basically there is only one thing they can do. They can stall the process so that the next President might not have such clear ideological and political goals. It makes absolutely no sense for Republicans to not use their Constitutional prerogative to turn down anyone the President might nominate. But why waste everyone’s time? So they are just telling the president to hold off. 

This debate has nothing to do with the Constitution and nothing to do with what past presidents have done near the ends of their terms. It is not about democracy. This debate is like everything else going on now – it is about people at the ideological ends pointing fingers and yelling at each other. Us folks in the middle keep shaking our heads and wonder how we got to such a place. Obama and liberals want to preserve the Obama legacy or at least prevent conservative decisions later this year. Thus they want Obama to appoint a progressive friend.  Republicans want to tear apart Obama’s encroachments and move the court in a more conservative direction. They do not want Obama to appoint a progressive friend.

So now we have one more thing for the Democrats and Republicans to argue about in the coming election. Instead of admitting that the Court appointment is a political issue the Democrats will say the Republicans are obstructionists who won’t allow the President to fulfill his Constitutional responsibility. The Republicans will counter that the Senate has a Constitutional duty to not agree to Obama’s nominee.

Does this surprise anyone who lives in a bifurcated America these days? The extremes have taken over and EVERYTHING has become political. Compromise is seen by both sides as a cop out. Each side clings to "It is our way or the highway". Why would appointing someone to the Supreme Court be any different? Pretty soon I will have to choose between a Republican brand of JD and a competing Democratic brand. What a mess. 

Tuesday, February 16, 2016

2% Inflation -- A Fool's Quest

I wrote a piece on January 19th about the Fed’s 2% inflation goal mostly saying that the 2% was a ruse – a way to take your eye off the ball. The Fed wants the unemployment rate lower and the economy stronger and the low recent inflation gives them the excuse to keep their pedal to the metal.

But there is more to the story. So let’s beat on the inflation goal again but in a different way. It seems clear why the Fed might want to adjust policy so as to reduce the unemployment rate. Higher unemployment hurts people. Lower unemployment is a sign of a healthier economy. I am not saying that the Fed is good at lowering the unemployment rate, but it seems to make sense that lower unemployment might be a desirable end.

During much of my lifetime, the Fed’s main goal was to reduce pesky inflation. That seemed reasonable too. Inflation is annoying. Ask folks who lived in any country ravaged by 100% inflation. Inflation hurts. Even when inflation hits 5-10% per year few of us like that. But the Fed tossed all that out lately. Their goal is to raise inflation. What? Why would they want to do that?

The answer has nothing to do with inflation or prices. The answer is that low prices might be an indicator of flagging or deficient national demand for goods and services. Influencing sagging spending makes sense but if you are concerned about low aggregate demand then why doesn’t the Fed come clean and say it is trying to raise AD? The answer is that AD is like love. Love is not directly measurable. Does she love me or does she not? We are always guessing about such things. If you want to know if someone loves you then you look at behavior. Apparently the Fed thinks it can look at measured prices to know what is happening to AD.

The problem with looking at inflation to gauge AD is that it simply is not very good for that purpose. For one thing, inflation reflects aggregate supply (AS) as well as AD.  When inflation falls because of increases in AS – then the Fed should not be reacting to that. So if the Fed has no direct measures of love or AD or AS, then inflation can be a dangerous and misleading indicator. When inflation falls is it because AD went down or because AS went up?  It is hard to know and reflexively presuming AD and inflation are the same thing has frequently led to grave policy errors and unnecessary economic suffering.

A second important problem with using inflation as a measure of AD is that inflation is like Steve Martin – wild and crazy. Inflation measures jump around like a kid on a red ant hill. Below I use some inflation data to make my point. The Fed might as well use lighting strikes to measure AD…it is a fool’s game to use inflation numbers.

My measures of inflation today are called implicit price deflators for GDP.  They are published by the Bureau of Economic Analysis and found at bea.gov with the various GDP statistics. Notice in the detailed table below there are inflation numbers for 2014 and 2015 for every component of GDP. This is a very comprehensive measure. It is broader than the consumer price index since it includes inflation rates of prices for things like plant, equipment, and exports. The closest thing to the CPI in this group is the deflator for personal consumption expenditures. 

I said above that inflation numbers are wild and crazy and could not possibly be good proxies for what is happening to AD or anything else. The overall index for inflation (for GDP) was 1.6% in 2014 and then 1.0% in 2015. The Fed would say that the national inflation rate fell and might be a problem if AD fell in 2015 and worsens in 2016. So far so good. But let’s look inside the wrapping of that sausage.

While the prices of consumer goods were falling by 2.9% in 2015 notice that the prices of consumer services rose by 1.9% after increasing by 2.3% in the year before. Note that the inflation of consumer services averaged those two years around 2%. Thus consumer services prices are at the Fed’s spoken limit. By the way, consumer services were approximately 65% of all consumer spending and 45% of GDP. In contrast, wild and crazy durable goods are only 13% of consumer spending and 9 % of GDP.  The durability of future inflation rates are much more associated with the heavyweight consumer services and much less influenced by wildly gyrating prices of consumer durable goods.

The GDP component we call investment includes purchases of capital goods – plant, equipment, software, buildings, and more. While consumers buy residential investment, the rest of these items are generally purchased by businesses. Notice the behavior of prices in this category. While the prices of the nonresidential portion of investment goods barely budged in 2015 (0.2%), prices of newly produced residences rose by 2% after rising by 6% the year before. Finally look at the behavior of both import and export goods.  Prices fell in those categories by 7-8% in 2015 after being pretty flat in 2014.

When you read the first line of the table and see that the US inflation rate fell to 1% in 2015 one might get the impression that the prices of most or all goods and services followed in lock step and somehow national AD must be on the decline. But this could be very misleading since the average masks a lot of different and conflicting changes – each one having a very different implication for AD or AS. Clearly spending on the biggest part of GDP, consumer services, was strong enough to put inflation of consumer prices at the Fed’s goal value. If you add prices of new residences, you get the same result – healthy enough spending to put inflation at 2%.

So what causes the impression that inflation is falling? Clearly sectoral issues that may or may not be AD in origin make the results very muddy. For example, prices of consumer nondurable goods retreated because of gasoline prices. Lower gasoline prices, however, should give consumers more money to spend on other items. Prices of imports and exports figured into much lower prices of those categories. Again, how much do these international changes reflect ongoing AD issues that our within our sphere of influence?

A closer look at inflation numbers suggests a mixture of temporary changes in highly volatile sectors and a mixture of AD and AS impacts. They paint a very unclear picture of how national AD is changing and a poor clue as to what will happen to inflation and AD in the future. The Fed should stop talking about inflation and be more honest about its true goal. The Fed has become Supergirl of modern times. Even the tiniest worry about unemployment or economic weakness sends the Fed into action. This was never the intention of the framers of the Federal Reserve Act and ignores all of the unintended negative impacts and imbalances that such policies have shown time and again.

Table. Inflation as measured by changes in
implicit price deflators of GDP
                                     2014  2015
 Gross domestic product 1.6 1.0
Personal consumption  1.4 0.3
    Goods -0.4 -2.9
        Durable goods -2.3 -2.1
        Nondurable goods 0.6 -3.3
    Services 2.3 1.9
Investment 1.8 0.6
    Fixed investment 1.9 0.6
        Nonresidential 1.0 0.2
            Structures 1.5 -0.5
            Equipment 0.7 0.7
            IP products 0.9 0.0
        Residential 6.1 2.0
Net exports            na        na
    Exports 0.1 -4.9
        Goods -0.7 -6.8
        Services 1.9 -0.6
    Imports -0.2 -7.7
        Goods -0.5 -8.9
        Services 1.2 -1.7
Government  1.8 0.2
    Federal 1.6 0.7
        National defense 1.4 0.2
        Nondefense 2.0 1.4
    State and local 1.9 0.0

Tuesday, February 9, 2016

Spending Spending Spending

Last week I spouted profusely about Federal government deficits and debt. I likened the government to the pepperoni pizza addict who ate the whole thing last week and this week not only ate his own large pie but also finished his wife’s left over clams with linguine (with a hint of hot red peppers).

It makes no sense to me that a government that goes into debt during a national and world emergency should plan to go even further into debt after the threat is well over. This is exactly how a nation flirts with becoming the next Greece or Venezuela. I show below how it might be possible do better than we are presently doing. It won’t be easy but it is possible. Waiting will only make it much harder.

For example, the results below show that with the spending and tax revenue projected for the next 10 years we could begin to chip away at the problem of deficits and debts. But it would take a decline in benefits of major mandatory spending programs of around 20% of the 2025 estimate. Of course spreading the pain among tax revenues and other spending would reduce that amount somewhat but it gives you a feel for what already must be done to get us back to anything approximating normal. If we add even more to debt in 2016 the difficulty explodes.

One of my alert readers who awakened from a thirty year slumber asked me off line to go a little deeper into the details behind the debt numbers. So for the sake of my huge (did I say huge?) and growing cadre of faithful followers I decided to strain my eyes and crane my neck over the reams of data published by the Congressional Budget Office. The most pertinent of those data are found neatly packaged by me below.

Before boring into the numbers, let’s do a little review of government budgeting. The government loves us and therefore deems it possible and legal to take money from the mouths of our children and distribute it over Iowa from helicopters. No I am just kidding. The government has the power to tax. In America the biggest federal taxes are imposed on income of persons and corporations. They also collect something confusingly called the payroll tax when in reality it should be called the let’s be nice to old folks tax. But naming these things is not my quibble today. The government also levies about 10 million other little taxes that are often collectively named “other”. Many of you are familiar with the gasoline tax that you happily pay each time you go to the pump and then buy a lottery ticket and a Twinkie.

The sum of these annoying federal taxes is labelled as Total Revenue below. You also pay taxes to your state and local governments but we will ignore those today. The table tells you that these Total Revenues amounted to almost $2.2 trillion in 2005. And no, Donald Trump did not pay your taxes or mine that year. Below those government revenues in the table are found the expenditures or outlays which are the ways the government gives us our money back. Yes, they take with one hand and give back with the other. Well – they actually give us back more than we pay in and that is the rub because when that happens and it usually does, the government goes deeper into debt. But I get ahead of myself.

Government spending is often divided into three main categories – mandatory, discretionary, and net interest. Mandatory spending means that these categories of spending are very difficult to change because if you change them Jimmy Hoffa will get you. Discretionary spending refers to items that are usually negotiated each year by Congress, while mandatory spending is set out in laws that extend payments into the future. You might say the future amounts are contractual. Notable mandatory items in the US budget include Social Security, Medicaid, Medicare, disability insurance, and more.  Surprisingly defense and many poverty programs are included in discretionary spending. Notice that since much of mandatory spending relates to people of my age – young people have a keen interest in how these spending totals are shaping up.

Last week I wailed about alarming increases in future government deficits and debt. This week I look into how spending and tax revenues generate those scary statistics. My comments come from the table directly below. The table divides and compares budget information for ten years into the past (2005 to 2015) and ten years into the future (2015 to 2025). The first three columns give you the budget numbers for 2005, 2015, and 2025. The next four columns focus on the 10 year changes (in dollars and in percents).

The time period from 2005 to 2015 starts with a strong economy, endures a recession in 2008 and 2009, and then recovers slowly from the recession. The future from 2015 to 2025 is unknown but the CBO estimates these future numbers based on relatively slow growth but without a recession.

First, debt is rising despite large increases in tax revenues. Tax revenues will rise by $1.5 trillion in the future after rising by a little more than a trillion in the past. Revenues will increase by 48% after rising by 51%. I am sure folks in the middle class would love to experience that kind of growth in their personal incomes.  Tax revenues will reach almost $5 trillion in 2025.

Second, the big generator of total revenue is income taxes. The future will see a rise of $988 billion or about 64%. Total income taxes will rise from $1.5 trillion to $2.5 trillion from 2015 to 2025.

Third, despite huge increases in government revenue – we are planning to increase spending even more – from $3.7 trillion in 2015 to $6 trillion in 2025. Wowee – that's an increase of 64%. That increase of $2.4 trillion in the future doubles the past increase of $1.2 trillion. DOUBLES!

Fourth, in 2005 federal spending on mandatory categories at $968 billion was less than discretionary spending of $1.3 trillion. But that was about to change. Mandatory spending is the big spending hog. Notice that while spending on mandatory items will rise in the future by $1.6 trillion (69%), spending on discretionary items will increase by $232 billion or by about 20%. Notice also that these discretionary future increases come after a decade of decline (-$154 billion or -12%). As of 2025 mandatory spending will be $3.9 trillion compared to discretionary spending of $1.4 trillion.

Fifth, notice that net interest spending increased by only $39 billion in the past but is expected to rise by $545 billion in the future. This is no surprise given how long the 
Fed has kept interest rates so low. This shows you the importance of the national debt. If the debt was to return to normal we might save a lot of money on interest. 

Finally, notice the last line of the chart. This shows you that we have gone from an excess of past spending over revenues of $319 to $438 billion to a future amount equal to $1.2 trillion. If we knocked the $1.2 trillion down to something more normal like $400 billion we would reduce the excess by $800 billion. $800 billion amounts to 21% of mandatory spending in 2025. But even this change does not stop debt from rising. 

2005 2015 2025 Chg Chg % Chg %Chg
Revenues Past Future Past Future
Income tax 927 1541 2529 614 988 66 64
Payroll tax 794 1065 1531 271 466 34 44
Corp. Inc tax 278 344 421 66 77 24 22
Other tax 154 299 337 145 38 94 13
Total Revenues 2153 3249 4818 1096 1569 51 48
Mandatory 968 2299 3875 1331 1576 138 69
Discretionary  1319 1165 1397 -154 232 -12 20
Net Interest 184 223 772 39 549 21 246
Total Spending 2472 3687 6044 1215 2357 49 64
Spending minus  319 438 1226 119 788 37 180

Tuesday, February 2, 2016

Ticking Time Bomb: National Debt

If I had a cartoon for this post today it would show the leaders of both parties smiling merrily with gifts extended in right hands while the left hands were plunging a dagger into our collective backs.

Recall last December when champagne corks flew and Congress declared it had come together in a great spirit of compromise to save the nation? Despite years of acrimony and accusations, these folks came together on the eve of the next presidential election and selflessly compromised by removing lids on spending while keeping most temporary tax cuts in place. Selfless? Ha ha. These elected officials realized that voters are not buying government standoff and they basically made Santa looks like a piker when it comes to distributing brightly wrapped gifts for all. On Dasher. On Dancer. Ho Ho Ho.

Well, the Congressional Budget Office (CBO) got around to estimating the budgetary implications of the 2016 Compromise Bill and they are not pleasant. In fact I think it is safe to say that we have finally arrived. We have finally arrived at the point of no return, the proverbial rock and hard place. We are out of bullets, yet our emboldened leaders are bribing and drugging us as they take us to the brink

Let’s suppose you go to Bank 1 and get a loan for a car. Then you go to Bank 2 and get a loan for another car. Bank 3 helps you buy a house and Bank 4 lends you money for your education. At some point it becomes pretty clear that even if you graduate at the top of your class with your coveted degree in Tiddlywinks, you will never have enough money to pay back these loans. Then you get sick and need to borrow money for expensive medicine.The next Bank says no way Jose. And your name is not even Jose. 

You explain to Mr Banker how much you need the money and he says no again. So you decide to reduce your spending on guava jelly and even with relatively large cutbacks on Jiffs Extra Crunchy Peanut Butter, you still can’t pay your existing loans much less the new one. So you ask your boss for a raise and he gives you 10% more. Hmmm…still not enough. Not nearly enough.

Stop crying Charlie. It is just an example. This example is silly Larry stuff but it makes a simple point. It is possible for a person or a country to have so much debt that there are no good solutions to their problems. Greece, Venezuela, Argentina, and dozens of other countries now and in the past have hit those limits and the results are both clear and tragic. At the point that the tragedy becomes known we all get very interested. We start asking questions – how did we get ourselves into this situation? What can we do to make things better?

The sad thing is that it is too late to ask those questions. The time for those questions was BEFORE things got so bad. BEFORE is when you can make adjustments. Those BEFORE adjustments are painful but they are nothing like the harsh boot on your neck when the creditors come after you…and then desert you.

Many of you are betting on just how many JDs I consumed tonight. But I am pretty sober and I am not exaggerating this mess.  What is so bazaar is that the US is now in a tragic budgetary position and these people running for office do not even have a clue. I will show you CBO projections below that are alarming. But the sad thing is that no one has picked up on it. No one and no party is debating this issue. Worse – many of these government folks want to legislate even more spending when they get back together later in 2016. Wow.

Here are some facts from the CBOs latest budget projections (cbo.gov):

·        From 2000 to 2007 government debt held by the public averaged around 34% of GDP. Let’s call that normal. In dollar terms the debt averaged around $4.2 trillion.
·        Largely because of the recession of 2008/2009, the debt increased to $13.1 trillion or to 74% of GDP by 2015. Let’s call that a huge increase but partly explainable by tough times.
·        After the 2015 Budget Compromise the debt is projected to rise to $16.9 trillion in 2020 or 78% of GDP. By 2026 the corresponding projections are $23.8 trillion and 86% of GDP. Let's call that criminal neglect.
·        If I am doing my math right, in 20 years, US government debt held by the public will have grown from about $4 trillion to more than $23 trillion. That’s a roughly six-fold increase. Notice it grew much faster than the economy as the share of debt will have gone from 34% of GDP to 86%. 

How do we get debt back down to something normal like 34% of GDP? How do I fit into my wedding suit? Not easily!  In the meantime, what happens if we have another recession and the debt goes to more than 100%? What happens to interest expense and debt when interest rates return to normal levels? How do we get back to something even approximating “normal” debt? Our so-called don't even talk about it. Instead they are boldly advancing plans to increase spending (free schools, more free healthcare, more submarines, etc) or looking for the lucky beans that will raise revenues (on the other guy) or magically increase output. 

Why isn’t hell already breaking out? There is a simple answer. For the time being problems elsewhere make us look okay by comparison. We survived the world recession better than most countries but part of the reason we did so well is that we went deeply into debt. Other countries had their own pluses and minuses – but right now many are in trouble. They won’t always be in trouble. And when they return to more normal conditions we will look much less good in comparison.

Japan and Europe will gradually improve. China will bottom and recover. Many developing countries will get pulled along when the developed world improves. As all this happens, our politicians will hope nobody looks too closely at US debt. As US debt pushes toward 100% of GDP or more and as better alternative investments arise, you can bet that US and global investors will shift their money to where in the world it seems safest. At that point there will be no easy fixes. We will feel the stupidity of policymakers who make us more and more vulnerable. It will be a mess. But our current batch of policymakers today is whistling their way to the bank. How do we get their attention?