The National Debt is okay because we owe it to ourselves. Right?

We owe it to ourselves. Nancy Pelosi among others has uttered this phrase as part of a rationale for why we should not worry about US Federal government deficits and debt. There are a couple of issues I would like to address. First, it is not true that we owe it to ourselves. Second, even if it were true, there would be good reasons to address the deficit issue. Let’s start with a simple but useful analogy.

I am retired so let’s suppose I need some money to finance a cruise to someplace really nice, like Alabama. 

So let’s say I need $1,000. I have some choices:

o   I can borrow the money from myself – that is, I can take the money out of my saving account. I promise to not spend some money later so I can replenish my saving account.

o   I can borrow the money from Betty. That is, I can ask her to take money out of her saving account. I promise to repay her in the future.

o   I can borrow the money from a bank in the USA. The IU Credit Union will deposit money into my checking account and after filling out 3000 pages of forms and leaving a blood and sperm sample, I promise to repay them in one year.

o   I can borrow the money from a bank in China. The People’s Bank of China will deposit money in my account along with coupons for three egg rolls at my local Chinese restaurant. I promise to pay my loan at the end of a year’s time.

If I repay the loans as promised then there is no big deal. But let’s suppose that after the Alabama cruise I get cruise-fever and can’t stop myself from going on cruise after cruise until I have ballooned to 300 pounds, sold my house, traded my collection of IU coffee cups, and basically declared bankruptcy. Does it matter how I borrowed the money? The answer is both yes and no.

It doesn’t matter how I borrowed the money in one sense – since there will be a negative repercussion in any case if I don’t repay. But the kind of unintended consequence depends on the source of the borrowing.

If I borrowed the money from myself then I cannot repay my own saving account. No big deal, right? Wrong! That saving account is what I was planning to use for important things in the future. Perhaps I was going to use that saving account to pay healthcare expenses or assisted-living housing. Getting into financial difficulty today has a real cost. It matters even if I borrow the money from myself. Postponing the repayment of the debt to myself means I transfer enjoyment from the future into the present. I might regret that later.

If I borrowed the money from Betty then we have a somewhat similar dilemma. If I do not repay her then we have an intra-household distribution effect. She has savings for important reasons too – for example all the nails on her fingers and toes must be attended to regularly by a licensed nail-professional. (I know I know – I am being very sexist here and I deserve whatever you decide to heap on my head. Please be nice.) Not paying my debt to Betty or postponing it means living with her ugly, ragged but personally-sharpened nails. I will regret that later.

If I borrowed the money from a USA bank and I do not repay it, then we have a national distribution impact.  My repayment was counted on by the bank to meet account withdrawals. If I fail to repay then bank depositors cannot withdraw funds they need for payments. Or perhaps the bank has lower profits or bigger losses. The stock values of my bank may decrease. Someone gets hurt financially and this has further impacts on others. Not paying my debt to the bank or postponing it means that the nation suffers.

If I borrowed money from a foreign institution and I do not repay it then we have an international distribution effect. This would be the same as the national distribution effect except that the impacts go to the foreign bank, foreign depositors, and owners of the foreign bank’s stock. Since fewer renminbi would be purchased in this case it would also reduce the value of the foreign currency. That raises the value of the dollar and makes it more difficult to sell US exports to trading partners. Not paying my debt leads to future impacts on foreign countries and the US (since we trade with China).

So Yes, it matters where I borrowed the money since the identity of the lender determines the nature of the distribution effects. But notice that in all cases there IS A DISTRIBUTION EFFECT and it is negative.  So in that sense it doesn’t matter.

You might say, I am missing the fact that an expected positive current impact was created and we have to pay for that benefit in the future. The expectation is that I will be able to pay my loan in the future. The problem arises only when something happens to prevent that. So it depends very much on what I presently use the loan for. If I use the loan proceeds for a productive investment, then the investment promises to pay enough to me so that I can pay the loan balance in the future. If I used the loan to finance a temporary change in consumption, then there is less chance for the payoff.

When Nancy Pelosi says we owe it to ourselves she is using a concept called net debt. Gross debt of the USA rises when the US government sells bonds or borrows – it is the value of the liability. But some or all of those bonds become assets to US citizens who hold those bonds. Suppose all the bonds were held by US citizens. When we subtract this asset value from the gross debt value we get a net debt equal to zero.  As a nation, we simply owe the debt to ourselves and thus we have zero net debt. But as the above cases suggest, we cannot ignore the expected distribution effects that arise when a debt is not repaid – or when we expect the debt will not be repaid.

When Nancy Pelosi says we just owe it to ourselves she is implying that we don’t have to worry about US gross debts that are owned by US citizens. But clearly she is being myopic and not considering the implications to ourselves once it becomes apparent that we are not managing that debt. We should worry about that debt to ourselves precisely because not paying it causes real and painful distribution impacts. Not paying off the debt means that the tax payers gains from the reduction of the liability. But not paying off the debt also means that holders of the debt do not receive their due. The net change debt change to the nation is zero – but the effect on the nation goes well beyond the concept of net debt as explained above.

We should have learned a great deal about debt mismanagement and how citizens of countries that have endured financial crises were harmed by it. Notice how much interest rates in Greece and Ireland rose once it became apparent that these countries might not be able to fully honor their debts. Those high interest rates insure slower economic growth and higher unemployment. And what about all those pensioners who held “safe” government bonds only to find out they were worth much less today than they were yesterday? When they are forced to cut back on their spending or sell their houses, how does that help them or their countries? These are the real world distribution effects arising from a nation that goes into debt because of unwise spending.

There is much risk of future declines associated with reneging on one’s debts even if we really owe it to ourselves. But it is not even a close call to say that we owe the debt to ourselves. Foreigners owned about $1 trillion in US government bonds in 2001 – by 2010 they owned over $4 trillion. They now hold more than 50% of federal debt owned by private investors and 31% of the total public debt. Should events lead to the US government being considered more like Greece or Ireland in the future, we would clearly have strong negative impacts on investors around the world. In addition to the government bonds, foreigners own another $13 trillion or so in private US bonds, stocks, and bank accounts – assets whose worth would also suffer from a US government debt problem.  

We need to face the facts. We spent decades getting into a fiscal crisis. We cannot wish it away with silly notions like “we owe it to ourselves.” Even if we did owe it to ourselves a debt problem would have very harmful impacts. But we owe the debt to countries everywhere and the harmful impacts will come from everywhere. The bottom line is that it doesn’t much matter if panic selling of US assets starts with John Smith or Lan Huang – if people think that US assets are worth less the results will not be pleasant. 

Aftershocks and Afterthoughts about US Economic Vulnerability in 2011

As I write this moment world stock markets are down again -- perhaps over-reacting but reacting nevertheless to a new bout of major uncertainty. Some forecasters believe this is the beginning of another economic meltdown. It is too soon to be making judgments like that but ff nothing else it should remind us about the fragility of the US economy and how vulnerable we are to shocks. In this post I continue my ranting about the urgent need to come to some agreement about future US deficits and debt. To not make progress makes us ever more susceptible to every shock that comes around. We are not making adequate progress largely because our political parties would rather squabble about traditional and sensitive issues than do the hard work of finding a way out of our debt mess. One morning last week, the headline in my local newspaper featured Vi Simpson, a respected leader of the state’s democratic party, declaring that the Republicans had declared war on the working man and the middle class. Yes, this usually intelligent and helpful representative of the Hoosier government used the “W” word. And she said it in public.

So now we are at war in Iraq, Afghanistan, and Indiana. Of course, the war she speaks of also has fronts in Wisconsin, Ohio, and DC. So I will now scream at the top of my lungs – YOU STUPID REPUBLICANS – YOU GOT WHAT YOU DESERVE. And the result is that moderate Americans who just want to see the economy improve have yet again been sucker punched by extremes in both parties. Are we so myopic (nice word for stupid) that we don’t see the game they play to perpetuate their own power? When are we going to recall all these extremists in our government and replace them with people who will focus on the whole country?

Surely when the Republican leadership meets they sometimes discuss the fact that their Democratic opponents and especially the extreme wing of that party can be pretty rough if not loud and ugly. What were the Republican leaders thinking when they decided that 2011 was the opportune time to take back all they had lost in recent years? Let’s make it impossible for gays to marry. Let’s throw water balloons at union members. Let’s re-write abortion laws. Let’s gut really popular government programs. Let’s make schools more like they used to be in the1950s during the Sputnik scare. Did I miss anything?

Really – was 2011 with a divided government the best time to irritate the other party by focusing on all their hot buttons? Really – was 2011 the time to let all the extremes in both parties elevate all their hot buttons so much that the REAL ISSUE does not have a chance to be debated and confronted in a contentious but eventually cooperative environment?

Some people say that this is politics as usual. But I beg to differ. This is politics at its worst because the leaders of both parties let their extremes dominate. I am not kidding when I say that I wish for the time when parties acted like real parties. They always had extreme factions – but there was a time when these extremes were thrown a few crumbs and told to sit in the corner. But look at Reid and Pelosi – they are a joke.  Boehner isn’t much better. They help these extremists throw Molotov cocktails at the rest of us.

The way we all go along with this destructive behavior makes you wonder if there is some elusive or hidden benefit we receive by smiling as the USS Titanic leaves port. Perhaps we like the freedom that allows all sides to express their opinions. Okay – that’s fine. Whether or not the armed forces have a “don’t ask don’t tell” policy is very important to many people. But do we really want to spend all our time RIGHT NOW debating that issue instead of coming to a real compromise on government deficits and debt? When the Titanic was going down people didn’t argue about unions. They focused on how to save themselves. The times require a solution to the most pressing issues. Yet we let the extremes persuade us that it is better to let the ship go down while we spend our last precious moments arguing whether Miller Lite is less filling or less tasty. 

Why do we sanction this destructive behavior? I think there are three key reasons. First, none of us like to admit that we have to go backward before we can move forward again. We got hit by a car, have numerous injuries, face a long rehab, and we are faced with the fact that there is no wonder drug to makes us immediately well again. Second, the rehab program is not without controversy. Good physicians disagree on the best programs because the body is complicated enough that no one can know exactly how a program will work. Third, we know there will be side-effects from the treatments and we fear the unknown. Faced with a very difficult situation it is understandable that we humans may want to postpone decisions even knowing that postponing may make things worse. As a result we are easily distracted and those at the EXTREMES see this as easy fodder for them.

So what do they do as we worry about very difficult and imminent challenges? They divert our attention to things that are guaranteed to arouse us emotionally. Hey guys, don’t worry about the Titanic going down – let’s watch re-runs of Charlie Sheen? Or maybe you would prefer Oprah? Let’s solve poverty today. Or maybe we should make sure rich people pay a larger share of taxes. PLEASE. These ARE important issues and we need to address them – but right now we have to sober up and focus all our energy on deficits and debt. Let’s not be duped by the extremists. We are smarter than that. Spillovers from the recent earthquake and tsunami ought to remind us of that!

Government Spending and the Law of Gravity

Despite having no real propensity in physics, I found myself in that course at Georgia Tech in 1965. I vividly remember a tutor, Professor E. E. Bortell, chanting for the benefit of us slow learners “What Goes Up Must Come Down.”  Actually Professor Bortell would say loudly – “What goes up must…..” and we could chime in “Come down.”  We did it over and over. It was fun and it kept us awake.

So what does that have to do with government spending? I checked the historical record and found that the federal government of the USA spent almost $93 billion in 1945. In subsequent years it went down to $55 billion, $34 billon, and $30 billion. It was pretty clear why the government spent less in those years – World War II was over and it was not necessary to keep spending at that rate. It took until 1961 before government spending reached $93 billion again.

We all understand that some things are temporary. We wear braces for a while but then discard them when our teeth are straighter.  Girls wear training bras until their stuff gets trained and boys get in fights until they learn that stuff about the girls. What goes up eventually comes down. Or does it? Even in the case of World War II there was some debate about the government reducing its spending. Alvin Hanson was a professor who believed in the Secular Stagnation Hypothesis and argued that reducing government deficits after WWII would bring back the Great Depression. In his view spending from the war only stopped the Great Depression temporarily. Without government spending the economy would forever be destined to economic purgatory (or worse).

Is that beginning to sound familiar? If we reduce government spending today, some experts believe surely we will have a double dip and it won’t be chocolate chip. The government didn’t listen to Hanson in the 40s and government spending was allowed to return to a more normal peacetime level. The government deficit had reached an intolerable $15 billion (almost 22% of GDP) in 1945 and returned to surplus for the next three to five years. Today we have a similar situation – we had a temporary surge in government spending during the recession of 2008/2009 and it is time to remove the surge. Or is it? Listening to our friends in government, you would think that what goes up ought to stay up.

Let’s think about the rhetoric as it relates now to the current budget-cut debate.  Think about the emotional and spirited language and gesturing you are seeing on the television. “By God man, you can’t cut that program. Think of all the misery you will cause.” But what does CUT really mean? What I show below is that most of what people are calling cuts are really what we might call a Restoration of Trend – or a return to a more normal growth path.

My focus in this posting is on what is called Federal Discretionary Spending (DS). What I am showing here could easily be expanded beyond the roughly $1.4 trillion we spent on discretionary programs in 2010. DS increased by $306 billion in the three years between 2007 and 2010. That was a 29% increase in three years. In the three years before, 2004 to 2007, DS increased by $146 billion or by 16%.  By any description, the last three years showed a HUGE growth of government wherein spending on DS was approximately double the growth in the previous three years. What value would DS have reached if it grew by the 16% instead of the 29%? Answer – about $1.2 billion or about $135 billion less than the actual amount achieved in 2010.  If in 2011 you took back or removed that extra $135 billion would that be a CUT or a Restoration of Trend?

You say I am playing with words. But this exercise is not about games – it is about making clear that HUGE TEMPORARY INCREASES in government spending are not entitlements that must last forever.  Taking back the $140 billion is NOT A CUT – it is restoring government growth to a sustainable pattern.  Notice that in the above exercise we are letting DS grow buy 16% in three years.  How many of you had increases in spending of 16% between 2007 and 2010?

Below I show the Restoration of Trend Amounts (in millions of dollars) for specific components of DS. The first column shows how much could be reduced from the program to allow it to grow in 2007 to 2010 by the same growth rate as it grew in 2004 to 2007.

Because of the technique used the items for the components do not add up to the total outlay amount. What you see here is how much we could reduce the spending in 2011 compared to its amount in 2010. For example, the education budget could be reduced by $44 billion dollars – and still allow the growth rate to have been 9% from 2007 to 2010. Notice that education spending actually increased by 83% in those three years. Would it really be a huge negative impact to give up some of that explosive growth? Did people become so addicted to the temporary increase that they cannot live with a 9% raise?

I won’t go through the table line by line but notice the last column and the extremely fast growth of spending during 2007 to 2010. Spending on Energy in those years increased by 179%. Except for the two line items at the bottom of the table, spending in 2007-2010 was much faster than in 2004 to 2007. This implies a few things. First, these increases were meant to be temporary.  Second, they are clearly unsustainable. Third, as the first column shows, there is much that could be reduced from 2011 spending and still allow a very rapid increase in spending. I am not suggesting that we remove exactly those amounts in the first column. We could remove more – we could remove less. But surely a prudent policy begins with understanding that these are in no way real cuts.


Note -- I had some trouble getting this table into the post. If it looks too  small to you I think you can just click on it and it will expand to a larger size. Sorry I am pretty lame at this kind of thing!

                   

Debt, Democracy, and a Double-Dip Economy

We are used to planning for the future knowing that things never work out exactly like we thought they would. Formally or not, we base our plans and actions on highly probable outcomes. I know that whenever I eat pasta I get sauce on my shirt and sometimes in my hair. It is predictable. So I wear a shower curtain at the dinner table. That’s what we do. We plan and prepare for events that have highly likely outcomes. And accordingly we do NOT plan for EVERY possible outcome. Some things are highly unlikely with almost zero possibility. While eating, I might learn that Madonna is going to join us for pasta primavera. For such a possibility I should be wearing only my best shower curtain. But, of course, I don’t because there is no way she is going to show up in Bloomington for dinner at my house. Accordingly we don’t worry about Martians or Charlie Sheen at the dinner table.

But there are events that fit in between the highly probable and improbable and we give them our attention.  We might say that we have a contingency or back-up plan for things that might happen, even if the probability is low. We buy life insurance policies when we are young because it is a prudent thing to do despite the fact that we might live through seven colonoscopies. Business firms hold costly inventories in the case that buying for their products is higher than normal. To NOT prepare for these possibilities is to be imprudent or we might call it risky behavior. NOT preparing for one-in-a-million unlikely events is excusable. Not preparing for somewhat unlikely events is not.

Today we don’t seem to know one unlikely event from the other. A terrorist plot to fly airplanes into tall buildings on US land used to be unthinkable – but now we spend a lot of money protecting ourselves from that kind of behavior. A financial crisis grips the US and the world – something that few of us prepared for but now has governments rethinking regulation and how markets should function. A revolution breaks out demanding democracy in Northern Africa and the Middle East – surely a plot for a futuristic novel but now all of us are scrambling to deal with the likely contagion.  One might argue that we should have known that all these things would happen. But the truth is that not enough people REALLY thought any of them would around the time they unfolded. They were pretty-much black swans. A black swan is a major event with very low probability – sort of like me driving to town without Betty telling me I picked the wrong route.

Today we are pausing to ask about the possibility of another major economic crisis or if such an outcome fits this black swan description right now.  To resolve this issue we have to calculate the probability of another economic collapse.  If a strong downturn is really highly unlikely, then it would be wasteful and costly to try to prevent it. But if it is not a black swan and there is something we could do, then we would conclude that our policy makers have their heads in the sand.

Recent events make me want to revisit the likelihood of another recession. We were cruising along pretty well in the last months – with lots of data pointing to a firmer economy. We are now seven quarters beyond the official end of the last recession.  Risk factors are well known and discussed frequently – the housing market needs more time to heal, government budgets need fixing, and emerging markets are causing threatening price rises of commodities, including oil. But the general consensus of most economists and the stock market is a rosy outlook with a small probability of a recession.

So why is Larry so cranky? I ranted recently about jeopardy – the idea that these risk factors should be given more of our attention. I particularly believe that government deficits and debt need our immediate attention.  Can we handle the debts now? Sure! But that’s not the point.  The point is whether or not we can handle the consequences arising from a few low probability events or shocks.  And last week pointed out how very unprepared we are.  Last week the political disturbances abroad caused oil prices to shoot up and our journalist herd quickly taught us how to spell S-T-A-G-F-L-A-T-I-O-N.  Last week we read and heard again about the 1970s and how and why a large and sustained rise in the price of oil might cause simultaneously higher unemployment and inflation.

A few journalists and economist s wrote more thoughtful explanations about why an oil crisis of the proportions we are experiencing today might not lead to as much economic wreckage as in the recessions of 1974 and 1980. But the point has been made. A black swan flew into our lake and left a big poo-pee. Maybe our economy will stick its nose up and go on with growth anyway. Or – maybe some white swans will join her and make the mess much worse. Right now we don’t know.

But this illustrates our choices. If we had a more normal debt position such an event might knock us around for a while – but having a large chain around our necks make us weaker and unable to deal with a large oil/commodities price shock right now.  If you had six months of earnings saved and in the bank when a bout of unemployment hit you, life would go on. If you have nothing but debts when unemployment strikes that is a much different situation. In that case it really hurts and you have few good options.

If stagflation hits the US – whether because of oil or the prices of other commodities – the US government budget position and debt will worsen even further.  The recession part of stagflation means that tax revenues will decline and spending will increase. The inflation part means many things – but surely interest rates will rise and cause mandatory government spending to increase.  And as most people know – stagflation puts the government and Fed in a no-win battle with inflation and unemployment.  Using traditional demand-focused policy tools, any policy designed to slow the rising inflation will make the unemployment worse. A policy more focused on the recession and unemployment will make the inflation worse. With fragile confidence today, can we really flirt with these outcomes?

Is the probability of stagflation high enough to warrant a faster and stronger approach to US debt problems? I think so. Clearly recent days indicate that the demand for democracy and the impact on oil prices is no longer a black swan.  But is the probability of continued disruption of oil markets high enough to warrant all the difficult political and economic changes that go with a fiscal solution? Clearly the expected payoff of a solution is huge. Imagine the newspaper story detailing the immense losses connected with the following headline – US unemployment rate rises past 10% as the consumer price index reach 6% in 2011. Why don’t we demand more from our representatives in government?  Let’s get this debt under control before the next sneeze becomes pneumonia. 

The Federal Budget Debates Focus on Spending Cuts. What Cuts?

I keep hearing about cuts in spending – and how various groups will be hurt by the cuts. This is strong evidence supporting the view that the government spending process never ends. Nothing is ever temporary. Nothing is ever enough. People get quickly accustomed to higher levels of government spending and feel entitled. No wonder they demonstrate in the streets when a program is challenged.

Data I present and discuss below suggest that the period from 2007 to 2010 saw huge increases in the growth rates of government. But that is only part of a story that begins with Y2K. Government spending has been growing about twice as fast as it was during the previous decade. DURING THE 2000s GOVERNMENT GREW TWICE AS FAST AS DURING THE 1990s.  The record shows that virtually every major spending category contributed to this spending bonanza. Since the two recessions of the 2000s contributed to this spending explosion, there is plenty of evidence to support the idea that what was supposed to be temporary was truly not.  When or where did Keynes say it was okay to stimulate the economy with government spending increases and then make the new spending level permanent?

Ideologues in both parties make it difficult to solve this problem. Why? Because they delight in infuriating each other with finger-pointing and guilt tripping. It’s all Reagan’s fault! Look at deficits in the 1980s. It is Bush’s fault – look at the growth of government under his rein. It is Obama’s fault – look at the last two years.

The extremes of each party act in this immature way because they want to stick up for their constituencies. They see the present crisis as a time to help out their labor union friends or stick it to the rich. Others want to gouge Planned Parenthood or get rid of healthcare reform.

But they are missing the point. Neither Planned Parenthood nor unions caused our current problem – a budgetary mess – one that is not simply an issue of the last few years. What I show below is that defense, discretionary non-defense, and mandatory programs have all grown at much faster rates in the last decade and especially in the last three years. I won’t repeat the data about the national debt – you know indebtedness is too high and rising too fast. In my last blog I wrote about jeopardy. While we might be able to sustain high national debt for a while longer – inaction means we raise the possibility of a financial crisis worse than the last one. So we need to get moving.

So why not admit that our immediate problem is not about the needs of special interests – but rather is about attacking a mountain of debt. If government spending rose by about $1 trillion in the last recession and much of that increase was to fight a recession, surely we can find ways to reduce that spending by $500 billion or more in the name of restoring normalcy and greatly reduce the chance that a financial sneeze will turn into a devastating situation with even more draconian policy choices.

I’d like to suggest that we go back to annual government spending  growth rates of about 3-4% – but that isn’t going to get rid of the debt soon enough. Even freezing spending to current 2010 levels isn’t going to provide much relief.  Taking the budget back to levels that existed in 2007 is not as hard as it seems. As the economy improves, automatic stabilizers in taxes and spending should improve the deficit by $200 to $300 billion. That’s a good start and we shouldn’t ignore that contribution. But it isn’t enough.

Automatic stabilizers accounted for $312 billion of the overall budget deficit in 2009 and $359 billion in 2010 – meaning that roughly 25% of the deficit deterioration was caused by the automatic (without legislation) responses of spending and taxes to the downturn. Or put another way – the budget deficit increased by about $964 billion in 2009. The automatic responses or non-legislated changes in spending and taxation to a downturn in the economy accounted for about $279 billion of that increase. The remainder, or $685 billion, was how much legislated policy change contributed to the higher deficit in 2009.

The upshot is that we could return to government spending of $2.7 trillion and a deficit of about $340 billion that existed in 2007 if we focus on legislated spending decreases that total about $700 billion in the coming years. The automatic stabilizer contribution will disappear on its own accord as the economy recovers. While the number $700 billion looks large if we describe it as a cut from the expected outlays in 2011 of $3.7 trillion, they look at lot more reasonable when you realize they are from what was supposed to be a very temporary and is now a very bloated (burp) level of government. If you gain 30 pounds of unwanted fat over the holidays you accomplish very little by saying that you are going to freeze your calorie intake after Christmas. What you need to do is have a plan to eat fewer Twinkies.

The following table summarizes the issue. The first and second columns show that government spending was about $1.8 trillion in 2000 and it subsequently increased to about $3.5 trillion by 2010. That’s an increase of about $1.5 trillion – or an annual compounded growth rate of 6.8% per year.  The third and fourth columns show what federal government outlays “would have been” in 2010 had government spending grown at a compounded 3.6% per year (same as the previous decade) or at 5% compounded per year. These amounts ($2.548 trillion/$2.914 trillion) are clearly less than the actual amount of spending in 2010 of nearly $3.456 trillion. The final column shows the extra or excess spending – actual in 2010 less what it might have been if growing at 3.6% or 5%. As you can see the range is from $542 to $900 billion.  Even if government had grown as fast as 5% per year we would still be able to reduce over $500 billion out of government spending. Friends – this $500 billion is not a cut – even if government had grown at 5% per year for 10 years it would have increased by $1.125 trillion during the decade. Of course if we think government should have grown at only 3.6% per year then we could reduce government spending by $908 billion and still have a government that showed considerable growth for a decade.

Total Fed. Outlays: Actual, Ideal, and Actual Less Ideal  

   (1)        (2)           (3)              (4)              (5)                   

2000     2010   2010 3.6%   2010 5%  Excess3.6/5             

1,789    3,456    2,548          2,914        908/542

Here are some further figures to ponder (All from the Congressional Budget Office http://www.cbo.gov/budget/budget.cfm )

Government Outlays        Compounded annual growth rates

2007 to 2010               8.2%

            2000 to 2007               6.2%

            1990 to 2000               3.6%

It is worth recalling that the increase in government spending after 2007 came at a time when the budget deficit was $342 billion and helped move it to $642 in 2008, $1.6 trillion in 2009, and $1.4 trillion in 2010. CBO estimates a deficit of $1.5 trillion in 2011.

This same decade-doubling pattern of spending growth shows up with respect to discretionary Domestic Non-Defense spending – with the annual rate of spending growing at twice the rate of the 1990s. Discretionary Defense spending also grew rapidly from 2007 to 2010 but it grew less fast than non-defense discretionary outlays and the decade of 2000 appears to be making up for no growth in Defense spending in the previous decade (and of course a reaction to global terrorism).  In 2010 Defense spending was $689 billion or about 20% of total government spending of $3.5 trillion. Domestic Non-Defense spending was about $614 billion or 18% of total government outlays.

Government Outlays: Discretionary Spending         
Compounded annual growth rates

Domestic Non-Defense       Defense

2007 to 2010               10.2%                           7.9%

2000 to 2007               6.4%                             9.3%

1990 to 2000               5.1 %                           -0.2%

The biggest part of the budget ($1.9 trillion in 2010 or about 55% of total spending) comes from what we call Mandatory spending. Between 2007 and 2010 total Mandatory spending increased by 9.5% per year. That compares to 6.2% between 2000 and 2007 and 5.3% in the 1990s. Consider these increases from 2007 to 2010:

            Compounded annual growth rates, 
Mandatory Spending           2007 to 2010

            Total                                     9.5%
             Social Security                    29.2%

            Medicaid                             12.6%

            Social Security                       6.5%

            Medicare                               6.0%

Mandatory spending, as the name implies, is not quickly changed. But since it is a major part of annual federal government spending and the budget deficit, it is too large to be ignored in this discussion. Since these programs are open-ended and change automatically with the economy, we can expect that spending on Social Security, Medicaid, and other programs will a decline automatically as the economy continues to recover. I discussed this above. But it is not unreasonable as we think beyond the next few years into the coming decade that restructuring of Mandatory spending be a key part of a fiscal solution. Evaluations of recent budget proposals show short-term deficit remediation followed by a period of deterioration…because of Mandatory spending increases as the baby boom generation ages.  Any plan that only addresses the next few years is going to be deemed a failure. So why waste time with solutions that are bound to fail? 

Obama Plays Alex Trabek with a Bull in the China Shop

There is much being written and said about the President’s new budget for 2012.  So much is being communicated that it is impossible for most of us to digest it all. In fact, confusion might be the intended strategy – so I have tried to boil it all down to a couple of main points. But let’s start with a silly Davidson story about a bull in a china shop.

“Sir, there is a huge mean bull wrecking your china shop”.  The owner replied, “I don’t see a huge mean bull wrecking my China shop.”  The man protested, “But look around you at the devastation – broken pottery and glass everywhere. Look at that big hairy animal in the middle of the shop.”

The discussion went on… The manager first said the breakage was not so bad and that he had a good insurance policy. He went on to explain that his shop was in a rough neighborhood and he had reported the problem to the police who would search around the neighborhood looking for culprits. He pointed out that even if there was a bull in his shop, that there was really little he could do. While some people might want him to shoot the bull, he would never resort to such violence. And, of course, trying to coax the animal away might lead to it running down the street and injuring other people. The manager decided to move some of his valuables out of the shop. Give me a little credit for not bringing in bull-c___. 

Point one is that even though a bull might be staring him in the face, Obama prefers to pretend like it isn’t there. While he might not believe in American Exceptionality he seems to believe that we can be exempt from the laws of economic gravity that weigh on every other country. If there is one salient and imposing truth about our economy it is that we had a huge and supposedly temporary surge in government spending during the last few years. If temporary changes in the government budget were legislated to counter a decline in private demand that was associated with a recession, then it seems that seven quarters after the end of the recession we would be focused on removing the stimulus. Of course, there is a legitimate debate about how quickly to remove it and I am not against a gradual removal. But I do believe policy credibility is important right now and a slow removal would require two things: (1) a strong statement about its importance and (2) a legislated multi-year process. 

There was no sense of urgency in the discussions of the budget for 2012. Yet this budget or anything like it puts the nation in harm’s way because it ignores what we have known for decades – that we spend too much and save too little. What does it take for our government to face up to reality – especially when other countries are getting the message and doing something about their own financial situations? Jeopardy is a very popular game but the word jeopardy is one I used many times with my kids. You place yourself in jeopardy whenever you make a decision that increases the risk of something bad happening to you. If you drive too fast you get places quicker. It might even be fun and exciting. But driving too fast places you in jeopardy since you might get an expensive citation or worst, you might injure someone.

Government spending and deficits make it possible for a nation’s people to have more now without paying for it now. But it comes at a cost – a future cost. If government deficits lead to critically large amounts of debt for a nation then the nation puts itself in jeopardy. At the moment all might seem well but all it takes is a negative blow to the solar plexus and the country could get doubled over in pain. It seems to me that the experience of the last recession should have been instructive. But apparently it wasn’t informative since we HAVE A MUCH LARGER DEBT BURDEN NOW and we pretend that having deficits of more than a trillion dollars in the coming years are okay. Even worse, while the current budget envisions the debt to GDP ratio slowing, it admits that any remediation is temporary and that it will resume its upward climb because of issues with Medicare and Social Security.

Clearly, then, this budget for 2012 offers no way out of jeopardy since it does nothing to provide a strong statement and action plan for improving the nation’s debt burden. It will be no black swan the next time a sudden macroeconomic shock negatively impacts Main Street or Wall Street or both. If you thought the recent recession was bad, just wait until the bond vigilantes suck their formidable assets out of US markets because we were the last kid on the block to learn from the last recession. 

Some would have you think there is a tradeoff or a distributional issue involved with attempts to solve the national debt problem. For example, the President’s plan has two disgusting features. First, it points its spending axe at programs aimed at those with low incomes. I am sure he knows that these aspects will never be legislated in a split government. He’s already heard a few explicative deletives from his friends on the left about the cruelty of his proposals. Second, he also plans higher taxes on those with incomes above $250,000. After compromising on this issue last year he tries it again because it looks good to his constituents to go after the rich. Of course, this will not be passed this year in a split government.  Much of what he has proposed, therefore, is disingenuous. Worse, it pits the poor against the rich. Yet today there is no real tradeoff. The poor and the rich will do better when the economy improves. It won’t improve until we recognize the bull in the china shop – until we seriously try to fix our real and looming debt burden.

Finally, he continues his theme from the State of the Union Address of proposing more spending on infrastructure and other competition-enhancing measures. It is true that our nation needs to be more competitive in the future. But risking our money on dubious government supported boondoggles rife with crony capitalism and corruption is not the right way to do this. I cannot remember a time in my life when there was more incentive for engineers and scientists and other entrepreneurs to be sequestered in their garages late at night trying to find solutions to so many pressing health, energy, and various high tech issues. The rewards for their successes are infinite compared to the extra pittances the government can hand them. If we do want to very carefully find new ways to support them with better infrastructure we should do it within the confines of a strong national financial and economic plan. These entrepreneurs don’t need handouts. They need a stable financial system with a large pool of saving that comes from both domestic and foreign sources. A bull in the middle of the china shop will do nothing to help American be more competitive. But it will generate a lot of c___ if we continue to ignore it.  

US Policy, Idaho, Onion Dip, and Rising Interest Rates

The news today was full of stories about rising interest rates. Rates are said to be rising because of a growing economy. The impacts of interest rates are one of the most complicated and misunderstood aspects of macroeconomics. Consider the popular discussions about interest rates over the last several years:

·         Interest rates rose before the onset of the current recession – that was bad.

·         Interest rates fell as the recession took hold. That too was bad.

·         The Fed instigated a policy to reduce interest rates further and that was good.

·         Interest rates are rising now and that is bad.

You might be saying – how can all that be true? It is possible only if you understand a little about cause and effect.  Here comes some macrofun! First, interest rates are fundamentally driven by changes in the demand and supply of credit. Whenever the demand for credit (borrowing) outstrips the supply (saving), interest rates rise as borrowers compete in a market that has an insufficient amount of saving available for their needs. The borrowers include households, firms, and the government.

Second, interest rates reflect the impacts of inflationary expectations and risk. If inflationary expectations rise or if financial risk rises – the savers demand a higher interest rate to compensate them for reductions in buying power associated with higher expected inflation and increased risk.

Third, while the above factors cause changes in interest rates, interest rates cause changes in the economy. Economists might use words like – “once interest rates change they create impacts in other markets for goods, services, equities, foreign exchange, etc”. So a full discussion of the impact of interest rates would include all the following:

·                X changes and impacts credit demand and/or supply

·                 Interest rates change

·                  Interest rate changes cause changes in spending, exchange rates, output, employment, etc

With this information and $3 you can get a coffee at Starbucks. You can also see why it is difficult to characterize and forecast interest rate issues. For example, interest rates were rising before the recession largely because spending in the economy was so strong that it created huge demands for credit. That might be considered a good thing because along with the higher interest rates was a very low unemployment rate. We like low unemployment, right? But wait, interest rates were also high because inflation and expectations of inflation were rising and the risk of a financial bubble were increasing. So the Fed decided to tighten the money supply and slow things down a bit. To do so the Fed drained money from the economy by selling government bonds. That added to the demand for credit even further and raised interest rates. The result was a clear realization by us all that housing and stock prices had peaked which quickly created a whole host of negative impacts on both Wall Street and Main Street. THE FED POLICY WORKED in the sense that it stopped the problem of rising spending. Of course, it worked too well since the unintended impacts on a very leveraged and interconnected global financial sector was a financial and real crash. Summary – rising interest rates were a sign of an economy growing too strong and they were bad because they led to a deep and long recession as well as a very weak recovery after the recession.  Whew—all that makes me hungry. Reward yourself with a trip to the refrigerator.

The above sequence of events led to very low interest rates – a mirror image of what came before – falling and low interest rates as a consequence of very weak aggregate demand, lower inflationary expectations, and a Fed that was buying bonds faster than a fox can eat lunch in a Kentucky Fried Chicken Store. Low interest rates were bad because they were associated with insufficient borrowing, weak demand, and the resulting very high unemployment rate. The lower rates were thought to be good because the Fed’s policy appeared to be necessary to resuscitate spending and the economy.

So let’s jump to today’s headlines which announce higher interest rates. Is that good or bad? You might be guessing from the above logic (optimistically assuming that you are still awake) that the answer is yes AND no. And you would be correct. Today’s higher interest rates are the direct result of a stronger economy and rising demands for credit. That’s good. Of course, today’s higher rates are also the consequence of rising inflationary expectations. That’s good news too if you worry that inflation is too low. Of course, if you look at any chart of inflation rates over the last 50 years you will notice that inflation has a tendency to rise beyond its goal value once it gets started moving upward. It isn’t the kind of thing that you can easily manipulate. It is a bit like that potato chip thing. Once you eat one salty, crispy chip with onion dip there goes Idaho.  So rising inflation is considered by some of us to be a problem. Not because we love Idaho but because without better policy we might be back where we were before the latest calamity hit.

Could today’s small interest rate rise really warrant all this concern? After all, Mr. Bernanke says that inflation is below target and we have lots of economic slack and high unemployment.  Bernanke might say – let’s wait until we see that we are clearly growing too fast. But that’s exact the issue. First there is the Idaho thing. 

Second, we have an unprecedented amount of liquidity just waiting to be spent thanks to the Fed’s policies the last years. Third, our government has an unprecedented amount of fiscal stimulus interacting with rising private demands. The firecracker might be wet and hard to light how. But watch out when the sun comes out.

It reminds me of the joke about the guy who falls off the top of a very tall building and as he is flying by the 10^th floor on his way down to the street a person sticks his head out of a window and asks “how are things going?” The guy responds that “things are fine so far.”  Well things are going fine right now as interest rates begin rising. I just hope Mr. Bernanke and our federal government don’t wait until too late to reverse engines. If not for America than please think about the potatoes in Idaho. 

State of the Union -- My Elephant Sat on Sputnik

Like many of you I sat in front of my TV with a bowl of JD and watched the President give his annual lecture to the freshman class – err I mean give his Annual State of the Union Address. This year I missed getting the chance to gaze into the eyes of Nancy Pelosi for an hour or so and was disappointed that Speaker Boehner did not cry one time. I know this post comes a little late but I wanted to have a little time to steal the best ideas from the 8 zillion people who already weighed in on the speech.

One response is that I really should be happy about the speech. I have been moaning about the negative tone of partisan politics and so I should really be elated by the fact that both the left and the right decried the speech a horrible disappointment. If both extremes were unhappy with the President, then it should follow that he took a big dive into the middle thus moving away from the extremes. But unfortunately I don’t see it that way. I think they are both right to be unhappy. And the reason is that the President may have proved to both sides and all of us just how thin his knowledge and experience really are.

Writing in the Financial Times on January 27, Robert Reich spoke for the left when he (Why our Sputnik Moment will fall short) said the following, “What he (Obama) should have done is talk about the central structural flaw in the US economy, the dwindling share of its gains going to the vast middle class, and the almost unprecedented concentration of income and wealth at the top.”  I won’t quote anyone from the right but it was pretty clear they were very disappointed to see him stress increased government spending as the way to improve America’s wellbeing in the future. He acknowledged a national debt challenge but didn’t seem very worried about it.

As one dedicated to the arcane science of simple cause and effect, I share the negative assessments of his speech largely because the president talked about lots of policy but hardly ever told us his view of the exact nature of our most pressing problems – or the causes of them.  While his smile and rhetoric are rare and his solutions dazzle the mind, his absolute lack of any sincere attempt to link his latest policy proposals to any realistic explanations of problems suggests to me that he doesn’t really understand them. Where is David Letterman when we need him – with a top 10 list of America’s worst economic problems?

To elaborate the point – while I don’t agree with Reich about the relative current importance of income distribution issues – one wonders after the speech what Obama thinks about that. Will emulating the Sputnik fervor with respect to education, green energy, and infrastructure alter the relative positions of the rich, the middle class or the poor? If so, can he explain how and why?  So much for people interested in policies to improve income distribution. Don’t we have a housing/financial crisis? Did we solve it already? Is it not REALLY important that our policy somehow connect to this problem? Shouldn’t he have spent a little time on this one thing that seems to have set off the worst recession since the day when bread cost 7 cents a loaf? Of course, if he thinks the housing/financial crisis is over or lacking interest, then maybe he might have discussed the fact that three years worth of federal government deficits are expected to exceed $4 trillion dollars between 2009 and 2011. Or maybe he thinks that’s honky dory and doesn’t need our attention in the coming year.

Reich has his stuff and I have mine – but the real truth here is that our President seems to have jumped on a satellite with the Dallas Cheerleaders and Dr. Phil – with the result a breathtaking lecture that continued his theme of hope and change without any real discussion of cause and effect.

Worse yet, hidden in a smoke screen of working together was an apparent switch to a new horse called competitiveness – without any real attention to what it means and how you get it. You don’t have to be a Republican to wonder what is the connection between some diffuse and rosy mention of improving education and what it really takes for the US economy to be more competitive. Democrat or Republican, you don’t really want to experiment with the people’s money right now betting on a very new horse.  If you were critical in any way of the stimulus story, then imagine what you are thinking about an abrupt turnaround of policy in the name of government policy induced competitiveness.

One more point. One theory is that Obama is weak when it comes to cause and effect. Another one is that he is VERY strong at politics. Notice that by switching horses and by agreeing to discuss details of tax restructuring, education, healthcare, and competitiveness policy—he will turn the spotlight away from him and towards all those folks who will debate themselves hoarse in the time leading up to the next election. Obama comes off looking like the great compromiser and both democrats and republicans will look like warring tribes of the bush.

The cat is out of the bag or you might say the elephant is in the gift shop – Sputnik is a great diversion but I think we would be a lot better off if we just erased our memories of his speech and started over – with some simple discussion of cause and effect and what our most pressing problems are today. 

Bernanke and Blinders: Making Distinctions Between Inflation and Relative Price Change

There were two articles in the Wall Street Journal on Monday about inflation. The articles raise many questions but central to them is the definition of inflation and what policymakers can do about it.

Most of us who are over 50 know what a colonoscopy is. Of course, we know it primarily from the user’s end – and by that you also know what I mean. But (and I do mean butt) most of us know very little about it from the doctor’s perspective. And while we might read the latest medical web sites, we really don’t have the training to understand all that is going on while we lay there on a cold bed with insufficient coverage of our precious parts.

Inflation is a word that most of us know. We feel the impact of inflation when our local grocer raises the price of bread and when a gallon of gas costs more than a double JD on the rocks. And we are constantly reminded about inflation since governments collect facts about price change and the press takes great glee in spreading the news each month. Then we hear that the Fed absolutely hates inflation almost as much as I hate anchovies and we feel somewhat relieved to know that Ben Bernanke and his colleagues are actively watching the numbers and are ready to attack like a head-butt in a Jets game.

Confusion may arise because inflation has two definitions. The first definition has to do with measurement. A price index is an average of prices. Some prices go up. Some prices go down. But the price index averages the ups and downs of all the items and calculates one number describing price change of all the items in the index. Food might be going up by 2% and horse shoes might be going down by 1%. The index doesn’t much care about individual changes because it averages them all together. Most price indexes are weighted – meaning they count some price changes more than others depending on how important the item is. We spend a lot more money on food than on horse shoes – so food prices are more heavily weighted or count more in the price index.

When we take into account all price changes in an index we get one number. For example, the consumer price index might be 202 this month. Perhaps it was 200 last month. So we would say that consumer prices rose by one percent (from 200 to 202). Or we would say that the inflation rate was 1% this month.

Okay – so the first definition of inflation is a measurement – it is the percentage change of a price index. This measure helps us to understand how far our income is going with respect to a particular basket or bundle of goods and services. Naturally when this measurement is high in a given time period, we don’t like it since it is telling us that our income is not stretching as far as it used to.

The big question is why this measurement of inflation matters for macro or for the Fed. So let’s wake up, do a few pushups, and move on to the second definition of inflation – macro inflation.

Recall that macro is about the national economy or the big picture. Macro is about aggregate supply and demand (If you don’t understand these concepts then I would suggest you go back and read all 60-something posts in my blog. Then you will be REALLY confused, give up, and go back to reading fun stuff.)

The Fed has no magic tool to impact the price of a specific single good or service. If food prices are misbehaving and causing the overall index to increase a lot, the Fed has no food price hammer to knock it back down. The Fed only has an aggregate demand hammer. Using traditional monetary policy to attack food prices would be notoriously inefficient since they would be using a macro tool that impacts ALL PRICES to whack away at food. The Fed’s tools are much better suited to times when the price index is rising because many or most of the items in the price index are rising (or falling) at excessive rates. This discussion gives us to ways to interpret a rise in the price index:

(1)   If it is being caused by only a small number of items, we call this RELATIVE PRICE CHANGE

(2)   If it is caused by many or most of the items rising, then we call that MACRO INFLATION

The hullabaloo in the papers recently is confusing because it is mostly screaming RELATIVE PRICE CHANGE and then wondering what the Fed is going to do about it. The Fed should, I believe, do nothing. Like a horse leading a carriage down a busy street, the Fed should be wearing blinders so it doesn’t get spooked by every little noise that signals a movement in prices.

So here is the fun part. While it is true that the Fed should not be tightening monetary policy because of recent changes in measured inflation – it should be tightening it because of other reasons. First, as the economy continues to improve banks will return to lending and spending and inflation will start to accelerate. Second, there is some risk that the Fed will wait too long to tighten the money supply and an inflation problem would be harder to douse once ingrained. Third, the combination of relative price change and a worry that the Fed will wait too long to address rising inflation can lead to a RISE IN INFLATIONARY EXPECTATIONS.  Fourth, a rise in inflationary expectations today causes behaviors that push up macro inflation today – as workers and other suppliers begin to press for their own wage and price increases. These behaviors are not only bad for inflation but they erode firm profits and could lead to a slowing of output and employment.

In summary – while current changes in the price index are not signaling higher macro inflation today there is, nevertheless, every reason to ask the Fed to immediately begin to lean against inflation. Without a quick return to a normal monetary policy we have the very real risk of a bout of stagflation similar to the kinds we experienced in the 1970s wherein both unemployment and inflation were rising. The only antidote was a virtual squashing of demand by the Fed late in the decade that sent interest rates above 20%. Let’s not go there again please. 

Angel Wings, three mumus, sweat pants, and Monetary Policy in 2011

When do you throw the angel wings away? My Dad threw me into Venetian Pool and told me to start swimming or I would sink to the bottom of the pool like a box of two week old Twinkies. Actually the water in the children’s pool at Coral Gables’ most unique swimming hole was only about two feet deep so my Dad wasn’t as callous as my sentence alluded.  Other parents purchased angel wings for their darlings. The angel wings hold the child on top of the water as they learn techniques of swimming – like moving your arms and legs in a manner that keep you on top of the water. They are a great idea. Once the kid masters the basic idea of swimming without fear of drowning, she can dispense with the wings and get on with trying to beat Mark Spitz’s records. The challenge comes with the more timid kids who are never quite sure their parents weren’t hiding in one of Venetian Pool’s dark and romantic caves making out. These kids were reluctant to give up the security of their angel wings and clearly jeopardized their ability to swim the English Channel. Their parents were faced with a dilemma. If we take the wings away our kid will NEVER learn to swim. If we don’t take the wings away our kid will NEVER learn to swim.

Martin Wolf and Ben Bernanke think that we are all reluctant kids who need our binkies or was that angel wings? Anyway M&B have been arguing of late that it is much too soon to start withdrawing monetary stimulus from the US and European economies. So I ask the question – will withdrawing stimulus now prevent us from ever swimming the English Channel? Or for you non-swimmers, will withdrawing monetary stimulus now mean that the economy will not recover? Or….tada…..will not withdrawing now imply the economy will not recover?

I think a clear and public plan to begin to withdraw the monetary stimulus is necessary right now. Waiting is foolish and will cost us. The reason is simple and relates to the angel wing example. Waiting creates self-defeating habits that are VERY difficult to reverse. Worse yet, reversing the policy too late creates unnecessary hardships. Okay – so let me dive into the deep end and splash around a bit. Sorry. I promise to not discuss angel wings one more time. But if you have never seen Venetian Pool in Coral Gables you REALLY have to see it.

M&B are like caring parents for more than 600 million people. They see an economy in the midst of a recovery, albeit one with less than hoped for employment increases. They see the risks surrounding another economic slowdown and do not want to contribute to an even longer and weaker recovery. Who can fault them for that? I guess I can or I wouldn’t be sitting here typing on a perfectly good day. It seems to me that postponing the inevitable puts central banks into a very bad position. Here is why. First, most of us know that the US economy will move closer to full capacity. At that time the Fed and ECB will need to generate more normal interest rates well above 0.25%.

Second, based on M&B’s unwillingness to raise the policy rate and tighten money after 6 quarters into a recovery, this raises the question as to when they will. Saying NO today means they are raising uncertainty for all of us. We know it is going to come but when? That matters to a lot of people.

Third, while we know it is prudent to raise rates at some point, how do we know they won’t raise them after inflation and inflation expectations have already firmed? Is it possible that we could be another 4-6 quarters down the road and still have a higher than desired unemployment rate yet inflation already starting to boil?  Will M&B continue to stall then? What exactly will it take to get them to remove the stimulus?  

Fourth, if inflation gets ingrained and rises above the Fed’s target this will surely cause longer-term interest rates to skyrocket. Even if the Fed stalls for a while longer – long-term rates will rise with or without a tighter Fed policy. This spike in interest rates without policy will be bad for the economy and the unemployment rate. If inflation jumps again and the Fed is finally impelled to reverse engines and raise interest rates—this could cause long-term rates to rise even higher. Remember 1979/80? Ugh.

But M&B promise to withdraw the stimulus right when it is needed. At the perfect moment when the economy is strong enough and inflation has not yet become ingrained in expectations, they will magically start the withdrawal. They want to do it this way to minimize the risk of hurting the economy with tight money. That is one risk. But what I am suggesting is that they are not considering the other side of the risk equation. History shows us that economic and political forces make it very difficult to identify the perfect time and that central banks often wait too late.  There is no such thing as just-in-time monetary policy and arriving too late has been shown to have disastrous effects.

 It is sort of like postponing a diet. You need to start right after Thanksgiving but you wait until after Christmas. Then you postpone to after New Year’s. But that would ruin your enjoyment of the bowl games. Okay – so you finally start the diet after the Super Bowl. At that point you need to lose a ton of weight plus you need to buy three mumus, four sets of sweat pants, and a small tent.  

Why I Want to Turn my Digital TV into a Hat Rack

Here’s a spout. Rose and Merlin were brother and sister. Rose played soccer and generally liked math. Merlin played in the orchestra and loved to photograph orchids. They hardly agreed on anything. Their arguments often got heated.  Rose would say – “you are mean and you called Daddy a monster.” Merlin would retort – “you are a pig and Mommy loves me more than you.” One day they were confronted by an evil visitor from outer space who threatened their very existence.  They were both worried but instead of working together to overwhelm the predator they took the occasion to yell at each other one more time. Rose started –“ if you had washed the dishes last night as required, none of this would have ever happened. “Merlin quipped, yes, but you are fat and ugly.” Rose and Merlin were never seen again.

So you are saying – Larry has clearly gone off the deep end. People have been saying that a long time so there must be another reason for me writing the above paragraph.

I am writing this paragraph after reading and re-reading my own words below and realizing it is possible for people to get the wrong idea – the opposite of what I am trying to say. The bottom line is that we have VERY challenging issues to deal with in the USA.  These are made even harder by a divided government. It is tempting to up the rhetoric but that might make it even harder to find solutions for security, defense, employment, health care and other pressing issues. The below spout is not meant to single out any one side or person.  As most parents find themselves saying – “I don’t care which one of you did it – you both can go to your rooms and right now!”  I am not taking sides here. Both sides can hate me equally!

I am REALLY irritated by the political fighting concerning the Tucson massacre of this past weekend. Some people are being somewhat careful with their words. Some are not. Let’s face it – some people on the left are using this shooting as a way to point a mean finger at their adversaries. They associate what is so far being called a crime by a deranged shooter with statements made by politicians on the right. In private people are saying what they really feel and they are even more ugly and vindictive about their political enemies. I don’t like to use the term political enemy but when I hear the adjectives some people use I cannot help but classify their categorizations of those with differences in political opinions as enemies. Of course, some of those on the right are not exactly making things better as they defend themselves and counter attack.

This is crazy. How many days will we spend listening to talking heads discuss whether or not the deranged killer was motivated by right-wing politicians? How much time will we waste hearing our right-wing friends defend themselves and counter attack and name-call their detractors?

Not all of the discussion is wrong headed if it seeks to protect better politicians and the rest of us from crazies and others who seek to hurt us individually or collectively.

But come on – most of what I am seeing and hearing is not directed that way. Here is what I don’t understand and what I am spouting about.

First, what religion or spiritual body of thought supports this mean-spirited talk?  

Second, why are they wasting our time with useless diatribes? Do we not have real and urgent problems to deal with?

Third, are our politicians so tired of battling the real and tough issues that they find it easier to lob stupid bombs at each other?  

Fourth, do these talking heads have some real data or information that has uncovered a plot by right-wingers to use weapons and other means of violence to take over America?

Fifth, have left wingers never advocated violence against the rich, big corporations, or the powerful?

Sixth, are there not always fringe persons in our free society who seek to incite fear, hurt, and kill the rest of us?

Seventh, would we not all be better off if we worked together to protect us from these crazies?

Rose and Merlin are fictitious people and the story about them is silly. But why do we act like them? The USA allows freedom of speech and we have a right to say intelligent and stupid things. Neither the left nor the right has a corner on the stupid statements. I just wish the rest of us weren’t so often brought into it. What irony. Now that I finally purchased a digital TV I find myself wanting to use it as a hat rack. 

2011 Kickoff

If you are like me you have probably already seen enough college football to last you until next Fall. But then, not many people would admit to being like me so let’s switch our attention to Brett Favre’s sexual exploits. That’s not what I meant. I meant Roethlisberger’s sex habits. No that’s not what I meant.

At this point you have either gone bowling or you are actually reading in excitement. So let me take advantage and switch to the economy and its performance in 2011. I am writing this on January 4^th so not much of 2011 is in evidence but I have noticed that the stock market has been very happy. That makes us retirees and hopeful retirees very happy. But will the fun continue?

That’s the $64,000 question and if that doesn’t date me then holy cow, what else could Edith? Those of you with short-term memories will remember that last year around this time we were very optimistic about the US economy but by spring and the unfolding of too much negative information about gyros and other Grecian statistics, we were wondering if we were in for a double dip – meaning that the US economy would fall from Grace and re-enter purgatory or even worse, you would receive a four-day visit from your closest relatives.

It took a while to climb out of that worrisome economic hole but here were again waiting for another Super Bowl and wondering if the economy will resume a clip fast enough to make a dent in the unemployment rate.   Macro is a great tool but being a practitioner of it doesn’t mean that I can forecast the economy for the rest of 2011. It is too bad that professional talking heads and journalists don’t have some humility because they get us all revved up for nothing but their own fame and wealth. They don’t know any more than we do but they sure look solemn and professional when they tell us about the future.

So if you have nothing better to do let me spend a little time explaining why I am generally optimistic but why I am not betting Betty’s Genesis on any particular outcome. What I do below is to explain why I think we might continue to recover but why there remain challenges that will impact the path of recovery. First, it seems to me that time has helped to heal the economy. While the stimulus policies helped to prevent a more severe downturn the main benefit is that the economy has mostly run its downward course. You don’t spend 10 years in rehab every time you get sick. The economy was not permanently injured by the factors that came together in 2007and thereafter to generate the recession.  The economy got punched and we adjusted to the punch. It was a hard punch so it took a while to digest. The good news is that we are on the mend.  The worst is over. The patient is on an upswing. But let’s not get too crazy.

Second, we still have some lingering problems. For example, housing experts believe that the foreclosure issue is still with us in 2011 (and beyond) and that means that housing prices may have to adjust downward another time or two. Most reports, I believe, see this as an orderly process. I interpret this to mean that housing news is 2011 won’t be good but it won’t interrupt too much the faster growth coming from other sectors of the economy.  I would expand this line of reasoning to include the broader financial system. While regulations have not addressed our problems adequately (too big to fail is one) I think time has helped to resolve the worst problems and debts are being worked off in the private sector.  As long as we don’t learn really bad unexpected news from housing or the financial sector, these sectors will only provide a small drag as we go forward.  Of course, that is one risk factor. If there are new unpleasant discoveries in the financial and housing sectors, then anything could happen.

Third, the big news item right now concerns US government debt and what our leaders in the government are going to do about it. There is the political silliness about extended the debt ceiling. Ignore that. We will not reneg on our national debt and everyone knows that. You guys have really fat wallets and the government has the ability to create infinite amounts of tax revenue at any time. So stop with that nonsense. What does matter is how we deal with reducing the debt. We REALLY need to have a plan and we have one brought forth by a commission at the end of 2010. The plan does not have to create extreme austerity forever and it does not need to create any real austerity until several years hence. But it does need to have an explicit and impossible to wiggle out of plan that reaches into the future. It must have credibility to bring government debt-to-GDP ratios back down to long-term averages.  Should our leaders legislate such a plan in the next few weeks that event will help the economy grow stronger now. Without it, we will lumber forward on the edge of a knife blade until the bond vigilantes get tired of harassing others.

Fourth – whether you call them bond vigilantes or simply grandma and grandpa – any hint of a significant resumption of the disastrous spending and saving performances of either our private or government sectors is going to lead to a economic calamity. Just like your child, presently a freshman  at Spendthrift U who cannot be given your credit card in his second semester,  our nation will not be able to find anyone willing to take the risk of lending us money – that is, buying our stocks and bonds . This eventuality will have the effect of raising interest rates, reducing the values on the stock market, depreciating the dollar and generating very slow growth – if not another recession.

So there we are.  We could have a nice reasonable story for the continuation of the recovery. But there are critical factors which include, at minimum, continued improvements in national saving and no unexpected or severe deterioration in housing or financial markets. With luck we might even see the unemployment rate begin to fall.  There is no magic to getting the unemployment rate back to 5%. In fact, I am guessing that what we call the “natural rate of unemployment” has significantly increased since firms have now found ways to reduce the employment factor in production for three years. Even with a spurt of sales I doubt they will go back to employment levels of 2007.

With households and governments taking years restoring saving balances, economic growth should not be spectacular. That is, do not expect a typical fast-paced recovery now nor in the near future.  Reality suggests that once firms become even more confident and optimistic about the future both output and employment will grow – the GDP gap will shrink and the unemployment rate will fall. This confidence will result from more time passing and the absence of negative surprises. So a gradually improving economy is possible. But those negative surprises with respect to housing, finance, and government debt policies suggest the possibility of something worse.  Time is on our side. Let’s hope our new government in Washington has the sense to minimize and not aggravate those things which will put us in reverse.