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.

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. 

Fedopus

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.

Entitlements

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. 

Millionaires and Billionaires

Wikipedia  (http://en.wikipedia.org/wiki/Millionaire ) defines a millionaire as one whose net worth is at least 1 million units of currency. A billionaire has about 1,000 times that much. Net worth is a concept that is calculated by subtracting what you owe from what you own. Furthermore, statistics tend to net out a family’s primary residence. In that sense net worth is essentially examining your ability to spend beyond your primary house. For example, if I borrowed $1 million from the Dumbhead Bank of Bloomington and I bought $1 million dollars of gold (or a second home or a Rolls Royce, etc) – that would not improve my net worth. I would have more stuff but I would also have a big liability to go with it. I would not be wealthier. If, on the other hand, I now own bonds, stocks, second homes and numerous cars and but I have no debt, then I would have substantial net worth that increases my ability to spend.  

Millionaire has a special and specific meaning. According to Wikipedia’s further analysis approximately 3 million persons or 1% of the US population is a millionaire in the sense of net worth. Wikipedia says that about 95,000 US families have more than about $30 million in net worth. Of course, there is some disagreement about the exact number of millionaires but I won't get into that here.

So what does all that mean? Let’s suppose your net worth is $1 million. At today’s interest rates you might be able to invest that money with little risk at about 3-4%. That means that your net worth could produce an annual income stream of about $30,000 to $40,000 per year. That’s a lot less than a plumber earns in most cities of the USA.

Which Americans have all that net worth? The answer is that half of them are retirees. That is, these are people who spent much of their lives squirreling away money here and there to take care of them in retirement. For those who acquired millionaire status as a result – they can live on a little more than $30,000 to $40,000 per year assuming they eat into the capital to live.

We hear some politicians saying they want millionaires and billionaires to pay more in taxes. So notice a couple of things. First, many of these folks are old people who spent their lives saving and probably live on less than $50,000 per year. It hardly seems fair to penalize these people. Second, let’s see what we can get from them. If there are 3 million people whose average net worth is $3 million, then by confiscating all of it we would net a one-time amount of $9 trillion dollars. That sounds like a lot of money. But think further. The US government will spend about $3.8 trillion in 2012. So that doesn’t make a lot of sense. We take away all their wealth and blow it in less than three years! What do you do in 2016? They have no more wealth left to take!  The estimate for the Gross Federal Debt for 2012 is a little more than $16 trillion. So a 100% net worth tax on all millionaires would still leave us with a debt of $7 trillion and no real means to keep it from rising thereafter by about $1 trillion a year.

No one has suggested taking away all the assets of millionaires but this illustration shows that if you took a more “reasonable” 20 - 30% of millionaire’s wealth -- it isn’t going to go very far to solve our problems. You cannot just increase the taxes on millionaires and billionaires and hope to avoid major changes in taxes paid by the middle class or reductions in the growth path for spending.

No one has seriously mentioned raising the necessary funds by taxing the net worth of millionaires. In fact, while the rhetoric focuses on millionaires and billionaires, tax policies are aimed at annual incomes. Much of what I read today defines policy in terms of adjusted gross incomes and mostly for families well below the million dollar income mark. I keep seeing numbers like $200,000 to $250,000. Since when is someone who earns in that range a millionaire? I agree that these people are doing pretty well. But do they really fit the vivid picture of a millionaire? Are they really people who are the envy of the rest of us? Are they people who somehow lied or cheated their way through society and now fail to pay their fair share?

I won’t sufficiently answer those questions because many people simply want to take from these folks regardless of the real situation. But maybe Joe made that much because he worked 16 hours a day for forty years at a tough job. He is now really good at his job and earns both respect and high income because few people have the skill or knowledge he brings to his job.  Maybe Tom is a retiree who saved for 50 years and now enjoys a decent retirement income. He made a decision that it was better to spend less in his younger years so he could enjoy some income security in his retirement. Maybe Ann worked her way through college, borrowed money for an advance degree, and is now a prominent scientist engaged in the development of new cancer drugs. Given our tax laws in the US – many of these people are entrepreneurs who forsake normal working and social lives and risk everything to start and run new businesses.

The point is that it is both rude and careless to stereotype. Stereotyping the poor is always frowned upon. But somehow making baseless conclusions and insinuations is perfectly okay when talking about people who hold $1 million in a saving account or who earn $200,000 per year. 

Rather than stereotyping anyone, one wonders why our politicians do not spend more time telling us why despite a long-term running war on poverty the number of poor people continually rises. When are they going to be honest and admit they lost the war and need to find out what went wrong. Why despite almost a century of social security have they failed to make it financially sound? Was the retirement of the baby boom generation starting in 2011 a big surprise? Did they not have 65 years to get ready for their retirements? It is sickening to stand by and watch politicians totally ignore their responsibilities to society while they insult us with meaningless demagoguery.  It is okay to discuss raising taxes. It is okay to ask wealthier people to pay more. But all this should be part of an earnest and respectful attempt to solve our national problems. 

Paul Ryan, Barry Manilow, and Edward R. Murrow

I don’t know about you but I am ready to turn my Walkman on full volume until election day. I’d rather hear Barry Manilow sing Mandy 10,000 times or have a double order of extra-garlic kimchi jammed into my ears than go through what is only going to get worse as we approach the Tuesday after the first Monday in November.

Mitt Romney chose a running mate and you would have thought from the bloody howls of the Democrats that he was supposed to pick Nancy Pelosi or Paul Krugman. Tone it down dudes – Paul Ryan is a Republican. As a result he has already signed a pledge in pickle juice to hate unions, emasculate females, reduce entitlements to a negative number, and find new ways to keep Romney’s average tax rate at .000001% of his income.

Sure, it is easy enough to turn off the TV, radio, iphone, ipad, ipod, car radio, and your next-door-neighbor, but geez, how did we get from there to here. And when I say there, I am remembering the time when you actually had to go downtown to buy a newspaper. Our TV had “rabbit ears” adorned with tin or aluminum foil and had a tiny screen that was best suited for a haze induced coma or some form of mediation. The closest thing you could get to news came from Edward R. Murrow and Ed Sullivan. Instead of somewhat objective news and commentary about once a week, we now get hot-off-the-press minute by minute reports and debates about Romney’s latest prostate scores. What a mess.

What can a moderate, thoughtful, rule-following, JD chugging person like you and I do for the next few months? My advice is to chew your meat at least 20 times before swallowing and to try to stay above the fray. While the former is easy to do, the latter is harder and takes practice. Just because all your relatives are extremist wackos does not mean you have to get sucked into arguments. For example, Ashley asserts that the world is clearly flat. Jason retorts that it is clearly not flat and explains passionately that it is hilly. Clearly all it takes is a quick drive though Brown County Indiana to see that the world is not flat. While Ashley says I always take Jason’s side, in this case it is best to stand back and let them argue. You and I and another 2 billion people who have passed third grade astrophysics all know that the world is a square planet that revolves around the moon but there is no real way to convince J&A of that point as they finger-point and mud wrestle.

That’s why I say that staying above the fray is important. Getting sucked into arguments between people with extreme views is basically a waste of time and good mental health. But that doesn’t mean one does nothing. It is true that it is hard to see a time when moderate views will prevail but one does not have to give up or give in. I once visited with Latvians who longed for the day when they would be free from the Soviet Union. They had to go through the motions each day as a Soviet citizen but many of them kept sane by planning for how they would again freely use their own language,re-introduce their former currency the Lat, and return to drinking copious amounts of Aldaris.

What does that mean for the people of the US? Could we please give up on identifying Romney’s tax returns and Obama’s college records? Instead we might want to think about some of the critical issues of the day. Health care problems were not solved by Obamacare. Just like Medicare D taught us, a new entitlement is going to cost us zillions more than initially anticipated. You do not have to be a Republican to wonder how we are going to pay for the healthcare services that will be required by tens of millions of newly eligible people. Then add to that the pressure of the boomers on social security, poorly funded private pensions, and the prune industry. Oh yes and we still seem to have a few problems left in housing, banks, and other financial institutions. No one has uttered a word about how to better reduce poverty and we have nothing but hot hair when it comes to facilitating job-creating long-term economic growth.

The point is that we have some difficult political decisions to make and while the zealots running our country now seem hopeless at even discussing whether to order white or wheat bread, it won’t hurt us to get educated about ways we can actually solve some of these problems.  If you want to learn how to build a house there are good sources of information to accomplish this. This approach is better than letting your neighbors drink your expensive wheat beer while they hotly debate the pros and cons of wood versus aluminum siding. The same is true for economic issues. There are many good things to read and programs to watch that avoid ideological purity.

Perhaps those of you who are still either awake and/or sober might help me with this discussion. Do you have recommendations for highly readable and minimally biased sources of economic information about our current economic problems? What do you recommend? Can you recommend a good source for housing problems? Healthcare policy? Maybe if we use this blog to share good sources of information that will help divert our attention away from all the stupid stuff we read and see. I promise (ha ha) to reward each recommender with a free bottle of virtual JD. 

I can kick this off a little bit. Most US regional Federal Reserve banks have publications, for example the Federal Reserve Bank of St. Louis publishes National Economic Trends and Monetary Trends. The US government has many good sources of information from the Bureau of Labor Statistics (employment and inflation), the Bureau of Economic Analysis (GDP and international trade), and the Congressional Budget Office. The World Trade Organization, The International Monetary Fund and the Organization for Economic Cooperation and Development are international organizations that among other things publish macroeconomic forecasts for the world. Your local college or town probably has non-political forums or guest speakers that are not always highly ideological.

I know what you are saying – Larry, this is like work. But let’s face it – you have a choice. You can listen to idiots shout at each other in bright, vivid colors with lots of useless and annoying commercials – or you can use that time to do something positive. Better yet, you can keep reading this blog and send money so that I can take care of my wacky relatives. 

Falling Off a Cliff? By Guest blogger Buck Klemkosky

Note from Larry -- I originally posted this article with an early draft. Please note below that I have inserted the proper and updated third paragraph. Apologies for excessive JD while on duty.

Falling off a cliff may be harmful to one’s health or even life if the cliff is high enough. In the U.S. a fiscal cliff looms in 2013 if Congress and President Obama do nothing between now and January 2, 1013. The fiscal cliff refers to the automatic tax increases and spending cuts that take effect in January 2013. Many believe that the combination of the tax increases and spending cuts will push an already slow-growth U.S. economy into a recession in 2013. The problem is that the U.S. has presidential and congressional elections in November 2012, and most of those up for re-election, including Obama, seem unwilling to address the fiscal cliff issue before the elections. After the elections, there will be a lame-duck Congress and perhaps a lame-duck president with little incentive to address fiscal issues. Many remember the U.S. debt ceiling debacle in August 2011 and anticipate the same political paralysis in addressing U.S. fiscal policy and the looming fiscal cliff.

The amounts involved in the fiscal cliff run into billions of dollars. The tax increases mostly center on the Bush tax cuts in 2001 and 2003, but also involve some of Obama’s tax cuts that will also expire at the end of the year. The Bush tax cuts were set to expire at the end of 2010, but were extended for two more years as a compromise in the last debt ceiling increase.

If the Bush tax cuts expire, the maximum individual income tax rate will increase from 35.0 percent to 39.6 percent, plus a recently enacted Medicare tax of 3.8 percent, for a new maximum tax rate of 43.4 percent. And this will affect not only high-income earners. The 10 percent income tax bracket will be eliminated and the upper levels of tax brackets will be 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent, up from 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. So everyone will pay more income taxes if the Bush tax cuts expire at the end of 2012.

Almost half of those who file U.S. income tax returns do not pay federal income taxes. However, even these will pay more taxes. Obama had cut the employee share of the Social Security payroll taxes from 6.4 percent to 4.4 percent and this provision also expires at the end of 2012. Since everyone who works pays this tax, all income levels will be affected. For example, someone with an income of $50,000 will see his or her Social Security tax increased from $2,200 to $3,200. Additionally, the so-called marriage penalty, which had been eliminated by doubling the standard deduction for couples and adjusting tax brackets, will return. Limits on itemized deductions and personal exemptions will be reinstated, meaning more taxes for higher-income taxpayers. Change in the alternative minimum tax provisions may also result in more people paying higher taxes in 2013.

Investors and wealthy individuals will also pay more as the tax on dividends increases from a maximum today of 15 percent to 43.4 percent in 2013 – the same as the tax on income. The long-term capital gains tax goes up from 15 percent to 20 percent, plus the 3.8 percent Medicare tax for a 23.8 percent rate. The estate and gift tax goes up from 35 percent to 55 percent, and the estate and gift tax exemption amounts drop from $5.1 million to $1 million.

So tax increases will increase government revenues. On the expenditure side, mandated spending cuts will be triggered by the failure of the congressional “Super Committee” to reach a long-term deficit reduction plan in 2011. The committee could not agree on $1.2 trillion in deficit reduction over the next decade, so the automatic cuts to all non-entitlement programs will kick in next year. Most of the cuts will come out of the defense budget.

Adding up the tax increases and spending cuts amounts to approximately $435 billion or 2.75 percent of 2012 GDP of $15.8 trillion. As mentioned previously, many are of the opinion that this will create such a fiscal drag that it will certainly push the U.S. economy into a recession in 2013 if not before. Economic growth has already slowed to annual rates of 1.9 percent and 1.5 percent in the first and second quarters of 2012, precariously close to zero or negative growth.

Can there be a silver lining if the U.S. falls off the fiscal cliff? Certainly in the longer term. Including fiscal year 2012, the last four federal budget deficits have each been more than $1 trillion and averaged 8 percent of GDP. The $5 trillion in accumulated deficits don’t appear to have helped the economy that much. The accumulated growth since the recession ended in June 2009 has been 7.1 percent, the weakest of all the post-World War II recoveries. The last three economic recoveries have been below par, but this one is the worst three-year performance to date.

So where is the silver lining? Since deficit spending has not stimulated a strong economic recovery, the $435 billion of tax increases and spending cuts may not be the Armageddon many fear. And they may rectify federal budget deficits that are not sustainable in the long run. This fiscal year, ending September 30, U.S. tax revenues are estimated to be $2.46 trillion or 15.7 percent of GDP, while expenditures are estimated to be $3.6 trillion or 23.4 percent of GDP. The projected deficit of $1.1 trillion means that only 68 percent of expenditures are funded by tax revenue. The rest, 32 percent, will be covered by the issuance of debt. Eventually bond investors are going to say, “Enough is enough,” and demand higher interest rates to buy U.S. Treasury securities. Historically low interest rates have helped the U.S. finance its deficits; much higher rates could be a catastrophe. So going over the fiscal cliff could help the U.S. get its fiscal budget under control on a sustainable long-term basis.

Resolving the fiscal cliff question as soon as possible may be more beneficial to the U.S. economy than whether we go over or not. The  uncertainty of the outcome has already affected corporate investment decisions and consumer spending. Less uncertainty will go a long way in helping the economic recovery. Too bad politicians don’t think that way.

How can you believe in markets when they seem so wrong?

To be more specific, world stock markets sprinted like scantily clad beach volleyball players on July 26^th and 27^th purportedly because both the Fed and the ECB gave signals that they are ready to save the planet from space invaders. Well not exactly space invaders but that is not out of the question. I can just see Mario Draghi dueling with ET! Because of actions and statements from these two mighty central banks, the world seems to be reassured the worst will not happen to our shared global marketplace. Evidence of this reassurance was the Dow’s climb to back over 13,000. Why would investors buy stocks at higher prices unless they were optimistic that things will get better and that stock values will increase even more? This is the market working – central banks act brave – people get more optimistic -- people buy stocks – and stock prices rise.

Just because markets are working it does not mean that markets are always correct. When I was a toddler in graduate school I learned about something called rational expectations (RE). My colleague at Indiana, Jack Muth, invented this idea and several macroeconomists (notably Thomas Sargent, Robert Lucas, Robert Barro, and others) were adding the RE hypothesis into otherwise dumber macroeconomic models (that assumed adaptive expectations). The cool thing about RE is that it assumed that people learn. That is – we are not consistently fooled. If Chuck Jolly sneaks up behind you in fifth grade and pulls your pants down enough times – you eventually learn to avoid Chuck Jolly or find a stronger pair us suspenders. In macroeconomics RE states that on average over time the public is able to forecast prices correctly. The words ”On average” mean that you learn. Sometimes you forecast too high. Other times you guess too low. But as an average over time you learn from your mistakes and get is about right. That doesn’t sound too crazy unless you think people are simply irrational and don’t much care. In that case I do not know what assumption to put into a macroeconomic model.

The point of the last paragraph is that there are no assumptions in useful economic models that assume that the public guesses right all the time. Thus, one can believe in the power of markets and still believe that the strong response in the stock markets was simply off base. RE says that when markets learn that they were wrong, then the market will adjust. In the case of the July performance cited above, it seems to me that the stock markets will soon reverse.  As a retiree who will live off the value of whatever stocks are left in my portfolio, I take no joy in making this point.

So why am I so pessimistic about the results of the Fed actions?

It is true that central banks have a lot of ammo. Central banks can inject trillions of dollars or euros at will and it’s as easy as slipping on a banana peel. So it is true that central banks can easily slip a bunch of money into banks. It is also true that in doing so, they can influence some interest rates. So if they buy a bunch of slip-shod mortgages, it is likely they can force the interest rate on slid-shop mortgages down a notch or two. If they buy Spanish bonds they can do the same. They can also promise to keep interest rates low until hell freezes over. In doing this they can try to convince people that the central banks will make it as easy to borrow tomorrow as it today. So why am I not skipping down Kirkwood whistling a happy tune?

First, look around you. There is no lack of money in banks and interest rates are not high enough to stop anyone from borrowing money. In the USA you can borrow gobs of money to buy that 19 bedroom house you always wanted as an assistant professor with a wife, 1.2 children, and a pet boa. This week you could borrow that money for 30 years at about 3.5%.

Second, pushing that rate to 3.2% by adding another trillion or so in dollars/euros will do nothing to get the economy moving. You can put more gas in the car but if it is on the side of the road with a dead battery, going from quarter of a tank to half a tank just isn’t going to do anything.

Why aren’t banks lending more money? One reason is that people are deeply in debt and they don’t want more.  Even devoted greens won’t buy another Chevy Volt if they are worried about the weak economy. Another reason is that the banks know the economy is weak and they do not want to be back where they were in 2008 when a weak economy wiped out their assets and made them look dumber than a bunch of rocks.  Notice the predicament here. If bankers and their customers were optimistic then there would be more lending and spending and the economy would grow. So if the Fed/ECB can make them more optimistic the whole problem is solved. But it doesn’t work that way now because there really is a dead battery and we all know it. If banks watch the Fed pour more gasoline into a car with a dead battery – it will make them MORE pessimistic not less! RE says that we learn. RE says that the central banks are making us worse off with their Dirty Harry approach to defending our jobs.

So what about this dead battery? What is really wrong? I don’t think any of this is a secret. Numerous governments in Europe are simply in trouble and this is leading to very slow growth if not a recession in Europe.  We use the term “fiscal cliff” to describe a pending fiscal disaster in the USA but the same problem is plaguing Europe. A fiscal cliff implies an unusually large reduction in government stimulus that would greatly reduce spending in an already weakened economy. China has its own problems as do many once hearty economies like Brazil, South Korea, and the Virgin Islands. Even Alfred E. Neumann knows that monetary policy is not the solution to a fiscal cliff.

There is no sense beating a dead horse. Monetary policy is being used to provide hope instead of a solution. Monetary policy is being used because we do not know what else to do. It is like the battery is on back-order and we don’t know when it will be delivered. So putting more gas in the car won’t hurt and it might make the driver feel a little better. But it is kicking the can down the road. Neither the EU nor the US is going to improve without serious attention to real problems. Private debt has to move towards normalcy. Banks need clearer guidance about what they can or cannot do in this uncertain environment. Governments have to bravely address their own debt problems without encountering a severe fiscal cliff. Business firms need more clarity about financial, health, environmental and other regulations. Central banks could hand out $1,000 gold bars to middle class people all over the world but that would do little to improve the economy or confidence about it. Since there is no thundering herd of politicians trying to solve any of these problems it is hard to see the stock market being happy much longer. 

Clintpublicans Did It. The CLIBUSHTA Urban Legend

Assigning blame is something we all do. It was the other guy who broke the expensive vase. There is nothing new in political candidates claiming success for everything good and shouldering blame for nothing. But the world is not that simple. National political and economic outcomes are surely the composite of many factors manifesting over many time periods.

One specific instance of credit/blame that I hear with regular frequency is the two-part conclusion that (1) President Clinton raised taxes, created a budget surplus, and that was good for the US economy while (2) President Bush lowered taxes, created a budget deficit, and that was bad for the economy. The truth of these statements have current application because some folks would like to make the point that raising taxes on the rich today will reduce the government deficit and would be a good thing for the US economy.

This blog post looks a little deeper at this urban legend about Clinton/Bush/Taxes or what I will refer to below as the CLIBUSHTA. In economics you get rich and famous by writing things on napkins or making up names like stagflation and disintermediation. So let’s see if CLIBUSHTA sticks.

The first thing I would like to note is that Clinton had a majority in both houses of Congress from 1993 to 1995. He was President for eight years from 1993 to 2000.  (see this source for congressional numbers from 1867 to 2009  http://arts.bev.net/roperldavid/politics/congress.htm ). During the remaining six years of his term the Republicans had majorities in both parties. We can label the 1993 legislation that raised top income tax rates to 36% and 39.6% as belonging to Clinton. But upon losing his majority the policy in the remaining years required bipartisan support.

My second point has to do with the behavior of the government budget balance during the Clinton years. The bipartisan Congressional Budget Office did a study (http://www.cbo.gov/publication/41238 ) which examined government budget positions between 1959 and 2008. There you find quarterly figures that show the US budget turning to surplus in the first quarter of 1998 and staying in surplus until the third quarter of 2001. Thus, Clinton-era budgets were in deficit during all the quarters of his first term and the first year of his second term. The budget turns surplus in his 6^th year in office and remains in surplus until the end of Bush’s first year in office.

So it is true that we enjoyed government budget surpluses for three of the last four years of Clinton’s second term in office. The CBO has another set of interesting data that decomposes the actual recorded surplus (or deficit) into two parts:

(1)   the part that is caused by deliberate policy action (called the cyclically adjusted  budget position)

(2)   the part that is caused by the changes in the growth of the economy (called the cyclical budget position)

During the 12 quarters of the Clinton/Bush budget surpluses, the effect of deliberate policy action was shown to be a negligible contributor to the measured surplus. That is, in none of these quarters were Clinton’s tax changes or CLIBUSHTA tax or spending policies a major factor in the surpluses. But the story is even stronger than that. In eight of the quarters, the policy part was contributing to a government deficit. If it had not been for exceptionally strong economic growth in those eight quarters, the budget surpluses would have been deficits. Interpretation – intended policy was to have government deficits but strong economic activity swamped the intentions and created surpluses.

What was going on in those eight quarters? First, the economy was in a long and strong growth cycle that started in March of 1991 and did not end until March of 2001. This 10 year economic expansion started well before Clinton came into office in 2003. It had the unemployment rate falling throughout but it is notable that it went from 4.7% in early 1998 to 3.9% in the final quarter of 2000. During this time period incomes grew rapidly and tax revenues increased despite a host of tax reduction measures taken in Clinton’s second term.

Clinton fans could try to take credit for these eight quarters of government surpluses but it would be a real stretch. Taxing rich people more had very little to do with this tsunami of tax revenue. What about the third year of surpluses? During Clinton’s last year of office (2000) it made sense that policymakers would be less interested in employment and much more worried about inflation. It would make sense as well to move toward surplus-generating policies. And that they did. But even in that year the effects of the economy swamped the policy impact on the surplus. During those four quarters the policy component had less than half the impact of the economy on the surplus.

To summarize, there is very little evidence from either of Clinton’s terms that his policies or those of the CLINTBUSHTA during his terms had much if anything to do with the resulting government budget position. Or to say it another way—there is no evidence here to suggest that taxing the rich creates surpluses and strong economic growth. The truth is just the opposite and more simple – something before Clinton’s Presidency and before Clinton’s tax increase caused economic growth to accelerate and that lead to automatic increases in tax revenue and automatic decreases in government spending. Budget surpluses were caused by growth not by tax policy during the Clinton years.

Without going into a lot of detail one can extrapolate this same point to the dismal economic growth and large deficits of the early Bush years. After the Dot Com bubble burst, we had a recession that began in April of 2001. Bush did not cause that recession in April 2001 any more than Obama caused the recession in 2008. Bush’s budgets quickly went into deficit and it was mostly because of stimulus policy. The recession pushed the unemployment rate from a low of 3.9% to a high of 6.3% by the middle of 2003. Government deficits were automatically increased by the slowing economy but very large tax cuts and spending increases combined to increase measured deficits to the neighborhood of 4% of GDP.

Again the story is the opposite of the urban legend. The latter says that Bush tax cuts caused government deficits and were bad for the economy. But the truth is that during a recession few governments are able to withstand the demands for stimulus policies. Bush was no different. But it is not the tax cuts and the budget deficits that hurt the economy. It was a weak economy that led to tax cuts and higher deficits.

Whether we look at Clinton’s or Bush’s terms – the lesson is the same. The economy caused changes in the taxes and government budget positions. Higher tax rates did not cause surpluses and strong economic growth – lower tax rates did not cause budget deficits and weakened economic growth. To think that higher tax rates on the rich or poor today is a solution to our budget deficits and economic woes is to misunderstand CLIBUSHTA!

Mutual Interdependence Admits Relative Contribution

 The latest useless debate between Obama and Romney has to do with whether or not business owners or other successful business people did it on their own. Obama says that we all benefit from some help from somewhere. Romney interviewed business execs who pointed out how much they sacrificed to get where they are. This is like them debating whether my mother or my father was responsible for my birth. Geez guys, this is a no-brainer – this is another red herring (no offense to smoked kipper) to keep our eye off the ball.

No business executive could honesty say that he/she never got any help from anyone. We can be bright and driven but surely somewhere along the way a lion pulled a thorn from our paw. At the same time, in addition to friends and luck, success usually requires long and hard hours and family sacrifice. People who put in the time often get rewarded. People who don’t work so hard or who choose less risky occupations get less rewarded. Mentors often tell you that you have to be in the right line if you are going to receive the benefits of luck. You have to buy that lottery ticket if you are ever going to win the lottery. Young people find it hard to see why learning math is worth all that effort. Parents tell them to keep working because someday that effort will pay dividends. Those who do not follow that advice take themselves out of the math benefits line. 

While it is true that both sides are correct, the question is which one is “more-correct” when it comes to influencing the economy. That is, if you want to improve employment and output, where do you aim most of your policy? Here I am going to say a few things that seem very practical and normal to me – but I may stir the beast in some of my friends and family. But what’s a blog for if not to lose friends and gain enemies? J

An accounting or a snapshot of a mature business firm finds it with owners, managers, machines, real estate, and labor and 6,000 lawyers. There are a lot of components to make a business tick. Each is critical to the outcome. If one part fails to do its job then the business suffers. The human body has a lot of parts. If one loses a hand or foot then the whole body performs less well. This snapshot suggests that we all rise and fall together.

But depending on the specific company, there are parts that are more or less important when it comes to the overall functioning of the business. Some small firms in some lines of business may not need a lawyer. Those firms can get by with someone who wears a coat and tie, bathes daily, and looks and smells like a lawyer.

Other firms need an inventor or entrepreneur to get started and to continue being competitive. Let’s face it there are many lines of business today whose continued existence is based on staying ahead of the competition. In that kind of firm, a particular plant site or machine might not be so important. To stay alive that firm needs a particular kind of scientist or engineer or manager. Lose that professional and the firm and all its parts go under. Losing a machine or administrative assistant means a challenge. Losing a key professional means losing the firm.  

Many start-ups would have never gotten started without a capitalist. A capitalist is a saver who decides to take an equity or ownership position in a new company. This capitalist believes there is a chance that the new company will succeed but understands that it might not. Most new companies fail. Capitalists also provide money for existing companies and the equation is the same. They give their money for a return not knowing in advance how big that return might be. Capitalists are indispensable. Talented professionals and high tech machines matter little if the firm cannot adequately buy or finance them.

Am I putting you to sleep? Good. I am told that a lot of my friends don’t get enough sleep. I am happy to help. Now where was I?

You hopefully are getting my drift that depending on the company some components are more critical or important than others. Most basketball teams need five players but let’s face it – Lebron and Wade get paid more and are more important than the others.  Somehow the other members of the team get this fact and are not insulted by this reality.

Now we get back to Obama and Romney. Obama is right that it takes a village to help a company succeed. So we should pay attention to all the parts. But let’s not mistake the fact that many companies exist and survive because someone took the financial and personal and family risk. A worker or manager in that company is important but it is usually much easier to find another assembler or industrial engineer than it would be to replace the guy or gal who spent endless hours and gallons of perspiration getting the company started to begin with. To ignore this basic intuition is to put logic on its ear. It not only puts the cart before the horse but it puts the horse in the cart! And that makes the horse very uncomfortable.

This point applies to many companies—large or small, new or old. Betty asks me what I do all day now that I am retired. Much of what I do is read the FT and the WSJ as I sip a nice JD – and learn about companies. Okay I also fume about Paul Krugman’s latest brain-fart but I spend a lot of time reading about companies. Every time I do that I thank my lucky stars that at age 21 I decided to never work in a business. I don’t have the nerve or the stomach to run a business. It is a dogfight out there folks. Ask the owners at Nokia or Research in Motion how they are doing financially. Ask the guy who just started a new restaurant in your town how much he is raking in.

 

Some workers are lucky. All they have to do is come to work and follow the company manual and not smoke funny cigarettes in the parking lots at lunch time. They have an "investment" in their company and they depend very much on that employment but in no way does that compare to what others put in. Some distant and rich investor might have a billion dollars tied up. The entrepreneur may have planned, dreamed, and put his/her life on hold for years to get the company up and running.

Note: I recognize that some firms are run by incompetents. Some of you read the last paragraph and fumed about the fact that you are a key employee and if given the chance you would run the company better after you fired the existing management. You might be right. My point in no way supports the existing management.  My point underscores that some productive inputs are more effective and important than others. When firms get this backwards then they do not succeed. You are proving that point. It must be very frustrating to work in a company like that. Luckily you have the freedom to argue your point or to move on to another company to show that you are right.

While this might seem normal and practical to me some of you are already saying that I have given the working class or the middle class short-shrift. I don’t mean any insult and have tried to say above that all parts are important and valuable to a company. I also fully understand how the income distribution has changed and I know that many middle income Americans have lost ground.  My concern, as is yours, is the best bath to help these Americans improve their lives. It seems backward to help them at the expense of investors, entrepreneurs, and innovators. It seems more sensible to focus on the mutual dependency among the parts. Let’s make sure rewards for entrepreneurial activity are commensurate with the risks. Let’s make sure that our companies can compete as effectively as possible. Let’s improve our education and training. Let’s remove impediments to hiring and firing workers. Let’s take away all those loopholes and stupid illegal and immoral relationships between business and government.

There is a way to move this country out of recession. We do it by valuing mutual dependence with a mature understanding about what it takes to both create and sustain competitive labor and product markets. We all work hard but that does not mean that some are not more vital than others. Our policies should celebrate this fact and not pit one side against the other with inane arguments about whether someone got help or not. 

LIBOR: The Biggest Financial Scandal Ever?

Thanks to Buck Klemkosky for being our guest blogger this week. Buck has been the dean of the SKK Graduate School of Business at Sungkyunkwan University, Seoul, since 2004. SKK GSB is the top MBA program in Korea and one of the top programs in Asia. Previously he was a finance professor and served as associate dean and chair of the finance department at the Indiana University Kelley School of Business. He follows the markets closely as a money manager as well. A version of this article recently appeared in the Korea Times.

Barclays, a 300-year-old British Bank, just paid a $453 million fine for manipulating LIBOR. Why the big fine? LIBOR (the London Interbank Offered Rate) is the most important short-term interest rate benchmark in the world. More than $10 trillion of securities and $350 trillion of derivative contracts are tied to LIBOR. Do the math and it is easy to see what impact a 1-basis-point change (one hundredth of one percent) could have with trillions of dollars involved.

The problem is that LIBOR is not a market-based rate but one set daily by survey. Each morning at 11:00 a.m. London time, 18 banks are asked the rate at which they could borrow from other banks in 15 maturities, from one day to one year, and in 10 currencies. Thomson Reuters aggregates the rates by rejecting the four highest and lowest and calculates the average LIBOR from the remaining 10 rates. This process is repeated 150 times for the 15 maturities and 10 currencies. Once calculated, the LIBOR figures are published and disseminated throughout the world. The most important of the 150 rates is the three-month dollar LIBOR.

LIBOR acts as a benchmark or reference rate for trillions of dollars of financial securities such as credit cards, corporate loans, home mortgages and just about any security that has a floating interest rate, as well as derivative contracts such as interest rate and currency swaps are tied to LIBOR. The impact of changes in LIBOR to borrowers and lenders is significant. For comparison, a one basis point (.0001) change on one $1 trillion of securities is $100,000,000. Given the $300 trillion to $400 trillion conservative estimate of securities and derivative contracts that are tied to LIBOR (some estimates are as high as $600 trillion), the amounts involved are huge.

Barclays had manipulated its LIBOR figure hundreds of times from 2005 to early 2009. Some were at the urging of its traders to help positions they had in derivative contracts and other securities. Also, during the financial crisis of 2008-2009, the bank purposely lowered its LIBOR bid because a higher rate at which banks could borrow would signal higher default risk. The banks that were too big to fail were under severe pressure at the time and any sign of weakness would have prompted massive withdrawals and/or a call for more collateral as counterparty risk was perceived to have increased. An interesting question is how involved or complicit were regulators during this time? They also were under tremendous pressure at the time to stabilize the whole financial system.

One thing you can count on in finance is contagion. The scandal has already spread from Barclays to other large banks that are under investigation or face lawsuits alleging LIBOR was manipulated. In Britain, the Financial Services Authority is involved, in the U.S. the Department of Justice and Commodities Futures Trading Commission, and Brussels in the E.U.

The LIBOR mess will be in the news for years to come. But it is not the only financial instrument to set rates by survey. There is TIBOR (Tokyo Interbank Offered Rate) and EURIBOR (Euro Interbank Offered Rate) that are similar to LIBOR. Many swap prices are also set by survey as well as other financial instruments.

LIBOR is the most important short-term interest rate in the global financial markets as the 10-year Treasury bond yield is for longer-term interest rates. The problem is that LIBOR does not reflect market prices or transactions as does the 10-year U.S. Treasury bond yield. Going forward, LIBOR and its equivalents should be based upon actual rates and prices at which banks have lent to or borrowed from one another, not estimates. At this time, LIBOR transactions are not publicly reported so there is a lack of transparency. There may not be current prices each day for all 150 LIBOR quotes but reported transactions should be the starting point, and that data used to fill in the blanks for those quotes not having transactions.

LIBOR has been around since the 1980s and has become one of the most important rates in the financial markets with huge financial implications for consumers, corporations and governments. And the market has been under suspicion of being manipulated for several years, but regulators never seriously investigated until recently. It is obvious that the present process of computing LIBOR is deficient. Given the amounts involved, the incentives to manipulate it are too large. Banks should not be able to profit from the level of LIBOR set by the banks themselves.

LIBOR may end up being the largest financial scandal of all times, given the trillions of dollars impacted by the rate. As mentioned previously, LIBOR will be in the  news for years to come. But what a global financial calamity it would be if LIBOR were to collapse. Hopefully in the future a better process can be devised to set a benchmark short-term interest rate that all lenders and borrowers can have confidence in as a real rate and not an artificial rate.

There may be alternatives to LIBOR. Some would suggest U.S. Treasury bills which are owned globally and traded in a liquid and efficient market. But they are subject to the creditworthiness of one country as opposed to 18 global banks. Another possibility would be to use the repo rate, which is the rate for financing securities. The borrower puts up securities for collateral for a loan and agrees to repurchase them at a later date at a specified price. So don’t be surprised if something replaces LIBOR.

Outsourcing Common Sense and US Jobs

President Obama quoted others in calling Romney and his past colleagues at Bain Capital “Pioneers at Outsourcing.” The President smiled and puffed out his chest as he proclaimed that in contrast he was the one who saved the auto industry.  Romney denied that either he or Bain Capital were responsible for outsourcing. But given the chance he did not take the opportunity to stand up for free trade. Thus they both want us to think that outsourcing is something evil that hurts US employment. As an aside, I think they used the wrong word – outsourcing instead offshoring. Their rhetoric works better for locating businesses abroad. But I suspect they like neither offshoring nor outsourcing.Both appear to hurt US employment. But keep reading please...

One quick thing to ask the President… he proudly bailed out the auto industry.  Is there any other industry that has done more offshoring of jobs? Does GM not have a plant in virtually every country of the world? Why is he so proud of saving the auto industry when he is so against offshoring? Has he vilified GM for all those jobs created abroad rather than at home? Why is it okay for GM to offshore but not okay for Bain to help other companies who want to offshore?

Those of you who are very worried about employment in the USA want your politicians to stand up for jobs in America. The disappointing labor department report last Friday underscored our concern for jobs.  But please, both these guys are agreeing on the wrong thing. Yammering against globalization is just wrong. It is very wrong.  Obama continues to take his eye off the ball. Employment suffers in the US because we have no fix for finance, housing, and a fiscal cliff. Yet he finds something new to talk about each week – he will talk about anything that diverts our national attention from what matters.  Romney does not do much better. I don’t care if he worked for Bain Capital or Micky D’s – I want a clear exposition of what he is going to do as President. Neither of these guys lived normal lives with paper routes and lemon-aid stands. I doubt either one would know the right end of a lawn mower.  Get over it. Both are running. What are they going to do once they get into office? This offshoring thing is a red herring.

Both these guys think they can score points with workers by pointing out that outsourcing/offshoring (o/o) hurts national employment. But stopping o/o is not going to save US jobs. It is important to see that o/o is not much different than importing goods and services from abroad. If we o/o or if we import we are buying things that are produced abroad rather than at home. On the surface it sounds pretty bad to import or to outsource. But luckily that is not the whole story.

We cheer for our good guys when export sales increase. When a firm on US soil sells more peanut butter to China, we acknowledge the extra jobs that are created in the US. Imports do just the opposite. Imports are goods that we buy and consume here that are produced abroad by workers in Brazil or Spain or Botswana. Clearly if those goods were produced at home this would create more job opportunities for Americans. But what has the president done about imports? During his watch US imports from the world increased from $2.54 trillion in 2008 to $2.66 trillion in 2011.  In 2011 US exports to the world were $2.1 trillion so we had a net deficit in goods and services of more than half a trillion dollars. That half a trillion dollars represents the difference between jobs gained through exports and jobs lost through imports. That’s a lot of jobs.  Why isn’t Mr. Obama traveling around in his fine bus ranting about all those imports? Clearly neither he nor previous presidents wanted to stop this trade deficit. It has gone on for decades. A Buy America program has done almost nothing to reverse all this.

Why is it okay to let imports replace US jobs but not to let o/o do the same? The answer is that it isn’t okay. Globalization is a two-way street. We all realize that you can’t have exports without imports. You can’t have in-sourcing without out-sourcing. A policy to reduce imports or o/o would surely hurt our exports and the desire of foreigners to invest here. Worse yet, it would be very inefficient and costly. Many imports reveal our own decisions to specialize. Importing things where we have no real business edge makes no sense. It would simply mean less choice and higher prices.  That is not what we are after.

Along similar lines, it makes sense to produce abroad rather than at home.  China and other parts of Asia are growing rapidly. They need a lot of goods to support the growth. Given the distance and cost of traversing it – it often makes sense to produce for those markets in Asia. Producing in the US would be more costly and we might lose in the competition with Asian, German, and other firms who also want to serve those markets. The reason the President doesn’t rail again GM plants abroad is that he knows that a global foot print makes GM a stronger company and more able to sustain its jobs at home as it spreads employment and production around the globe.

Why has Obama been so silent about the recent decision of Airbus to locate a production facility in Alabama? Obama does know that Alabama is one of the 57 US states, doesn’t he? I realize Alabama is a right-to-work state but even non-union workers count in the national employment statistics, don’t they?  Why did Airbus decide to locate in the US? Did they do it to irritate French workers? The Wall Street Journal says the location decision was made because Airbus wants to be able to produce for the US government. To be competitive in government procurement a company must have factories in the US. Is it not possible that many US companies locate abroad for similar reasons – whether they serve government or private purchasers? Isn’t Airbus made stronger by locating a plant for US buyers in the US? Are not jobs in France and other places in Europe made that much more secure because Airbus is stronger? So it makes sense for France and other countries to o/o.

Let’s take a look at offshoring in a comparative sense. You will see below that the US is just doing what everyone else is doing. We are clearly not alone.   In 1990, the US owned $732 billion in foreign capital (Foreign Direct Investment, FDI*. A more complete definition of FDI is given below.) That is, US cumulative purchases over many decades of foreign productive capital across the globe amounted to $732 billion. That amounted to 13% of our GDP in 1990. We have since experienced more than 20 years of rapid globalization and now own $4.8 trillion capital abroad. That amounts to an almost 7-fold increase. FDI was 32% of GDP in 2010. Offshoring is very evident for the US.

The below table compares the US to 10 other countries and the EU: (this data comes from the United Nations Web Table 8. FDI outward stock as a percentage of GDP, 1990 to 2011. Stock values are in trillions of dollars). http://archive.unctad.org/Templates/WebFlyer.asp?intItemID=6018&lang=1

The stock of FDI owned by the EU was almost twice as large as that for the US in 2010.  The listed countries own from $340 billion (Switzerland) to $1.7 trillion (UK) of FDI in other countries. What matters more, however, is how large the ownership compares to the size of the country.

For the Netherlands, FDI was 123% of the economy in 2010.  The US position was 32% which ranks it about 9^th in this list – at par with Australia. Only Japan and Italy have FDI lower as a percent of the economy than the US.

Consider the increases in dollar value since 1990. The US FDI increased 7 times. That sounds like a lot but over these 20 years only Japan had slower growth in FDI at 4 times. Spain’s FDI increased 41 times! The median country’s FDI increased 8 times. Spain, France, Switzerland and the EU all found FDI increasing in double digits.

Globalization means investing at home and abroad. Countries that don’t do it will lose out on opportunities and will not compete well. Between 1990 and 2011 US non-farm employment increased by 23 million jobs. Private sector jobs increased by 19 million. The New Age of Globalization saw American jobs at home increase by more than 20%.

                   Stock      FDI        Fold increase

                    FDI         %GDP       Since 1990

                    2010      2010

EU            $8.93tr      57%               11times

US              4.84        32                    7

UK             1.69        72                    7

France        1.52         62                  14

Germany     1.42         44                    9

Netherl         .89        123                   8

Japan           .82         15                    4

Spain            .66        46                  41

Canada        .62         41                    7

Italy              .48        24                    8

Austral         .40         32                  11

Switzerl        .34         80                   8

  

*FDI is meant to capture the value of purchases of companies abroad for the intent of management control. It does not include purchases of foreign stock that are made for the purposes of only financial investment. That is, most international bodies distinguish between FDI and portfolio investment. FDI involves the purchase of companies through merger, acquisition, or simply enough shares to lead to some managerial control. It also includes greenfield sites which would include building a new plant or business firm in a foreign country.