US Unemployment, Garter Belts, and Lemonade Stands

When the US unemployment number came out for September it was followed by a firestorm as hot as a kimchi pot in August. The Democrats were delighted that the unemployment rate had fallen below 8%. They were even more delighted that the number of people finding employment had increased by a whopping amount. Who could argue with that? The Republicans, of course! Digging deeper into the September number they found that much of that spectacular increase could be explained by part-time employment and by people moving into self-employment. One interpretation was that the reduction in the unemployment rate was a negative signal – revealing that desperate people had moved from unemployment to part-time work or had at last gasp started their own lemonade stands.

So which one is right about the implication of a falling unemployment rate in September? NEITHER IS RIGHT.  Both are wrong. Both are wrong for the simple reason that you cannot judge what is happening in the US economy from one month’s sample. The household employment survey is notoriously small and therefore it has a lot of variability from month to month. The huge increase in September, for example, followed weakness in the month before. It is possible that some of the employment that was reported for September actually came at the end of August and that the former was underestimated and the later overestimated. This happens all the time with monthly data. It is also possible that the sample was biased by unusual outcomes. For example, weather, holidays, timing of back-to-school sales, and other unusual factors may have made September 2012 different from past Septembers.  

So what we usually do is try to interpret monthly changes as best as we can but realize we need several months of outcomes before we can assign a new trend to the economy. September numbers say almost nothing about the direction of the economy.

We need to look at longer trends in this data. So I took a little digital trip to the Bureau of Labor Statistics (www.bls.gov). They are nice enough to have relevant data back to 1612 when Columbus discovered Plymouth Rock.  Because of my great respect for Great Britain and statistics, I decided to confine my hunt for data to years since 1990. And I found some interesting things.

First, let’s back-up and define what we are talking about. Each month the Labor Department surveys companies about payroll jobs. That number is reported to the public despite the fact that it does not enter into the calculation of the unemployment rate. The payroll jobs number was not in dispute in September.  It showed some modest employment growth at non-agricultural companies as it has been doing of late. This post is not about the payroll jobs number.

The Labor Department conducts a second survey each month. In this case they talk to a sample of households and ask the persons in that household about their status in the labor market. Do they have a job? Is it part-time or fulltime? Is it for a company or is it self-employment.  Does it involve Jack Daniels? Are they now looking for a job? Does the dress requirement of the job invovled high heels and garter belts? And so on. Based on the answers the government estimates the labor force, employment, unemployment, and the unemployment rate.

Second, rather than focus on month-to-month changes – let’s see how some of these key labor market indicators have behaved over more extended time periods. The largest employment category published is what they called Wage and Salary Employment in non-agricultural companies. In September of 2012 it was estimated to be 111,024. Yes, it leapt by a considerable amount compared to August of 2012. But what has it been doing over a longer time period? One benchmark is before the recession began when it was 113,298 in September of 2007. We can conclude, therefore, that household employment at firms remains lower in 2012 by 2.3 million employees.  So we are not back to where we were in 2007.  Employment in this category decreased to 106.5 million in 2009 and has been improving since the worst of the recession.  It increased in 2010, 2011, and 2012. This gradual growth is very compatible with what we have seen from the payroll survey employment figure – modest growth but so far we have not caught up to employment levels of the 2007.

Of considerable interest is the measure of part-time employment. Plotting it over time reveals that it is very counter-cyclical – meaning that it increases in recessions and then dramatically reverses in strong economic years. In the strong economic growth between 2004 to 2006 the number of part-time jobs held by household in the USA decreased by 18%. From 2006 until now part-time employment has increased by more than 100%! Now that is volatility.

But more than the volatility is the number. Between 2007 and 2009 the number of wage and salary workers decreased by 6.8 million. Part-time jobs rose during those two years by 4.5 million. Bringing us up to present, between 2006 and 2012, the number of wage and salary jobs decreased by 2.3 million persons. The number of part-time jobs increased by 4.1 million. Clearly from 2006 to 2012 there was a conversion away from full-time work to part-time.

But what about the changes occurring more recently? From 2009 to 2012 the number of W&S jobs increased by an impressive 4.4 million jobs. But we don’t know how many of those were fulltime positions. We do know that during that time the number of part-time jobs remained stubbornly high.

What we take from this analysis is a very different story than what we get from one-month changes. While things have improved for wage and salary workers in the last few years we still have about double the number of part-time workers we usually have. Progress is being made. But we are still not back to past benchmarks and that is why the unemployment rate is still much too high to satisfy anyone. Obama can gloat that employment does seem to have turned but clearly we are not back to levels of the past and we have many too many people working at part-time employment who don’t want to be there.

That leaves the issue of the self-employed. While this category of employment did increase in September 2012 there is no clear pattern in recent years. It did rise gradually between 1990 and 2007 and then has generally fallen. Since 2007 it is down by about 7%. It fell by about half a million jobs from September 2011 to September 2012. This deviation from the longer term trend suggests less confidence in self-employment.

In short, employment is growing but too slowly. Households are finding more opportunity at non-agricultural firms but many of these are part-time positions. Households have slowed their attempts to start their own businesses. The economy needs more growth to make a difference. The parties should argue about the best way to create sustainable growth – not about September or October’s employment number.

Note: this post is long enough without getting into the related issues of the ideal way to measure unemployment. The unemployment rate that gets the most attention each month considers a part-time job the same as a fulltime job. Alternative measures do not. Furthermore, other measures estimate how many people belong in the unemployed category who dropped out of the labor force. As a result there are measures of unemployment that range from 17% to more than 20%. That is the topic for a future blog.

The Age of Uncertainty

By Buck Klemosky -- Guest blogger. Buck is the former Dean of the Graduate School of Business at Sungkyunkwan University in Seoul.

“The world seems more uncertain today than at any other time in my life,” stated Howard Marks, a successful money manager for nearly 50 years, to his Oaktree clients. John Bogle, the legendary founder of Vanguard echoes the same message in the New York Times: “This is the worst time for investors that he has ever seen – and after 60 years in the business that is saying a lot.”

The source of this uncertainty comes from the Eurozone, the U.S. economy, the global economy, the Chinese economy and other developing countries, QE3, corporate earnings, confidence on the part of both consumers and corporate leaders, structured deficits and sovereign debt, the fiscal cliff, the depressing state of politics, and government regulatory initiatives

A long list of problems and challenges, to be sure. But they all lead to four possible scenarios for the U.S. economy:

1.       The U.S. replicates Japan’s experience of slow growth and deflation in the next decade.

2.       The U.S. economy falls into a recession in 2013.

3.       The U.S. economy returns to normal with real growth of 3.0-3.5 percent.

4.       The U.S. economy experiences higher than expected inflation (2 percent annually), which could be coupled with a growing economy or a stagnant economy.

Because of the uncertainties mentioned earlier, it is extremely difficult to assign reasonable probabilities to the four scenarios with any degree of confidence. Europe continues to be an unsolved problem with huge risks and much uncertainty. We are not sure what should be done to fix the problem, what can be done, let alone what will be done. The best that can probably be expected is that Europe will muddle through.

The U.S. fiscal situation is a mess. Long term, the entitlement programs need to be curtailed, the fiscal deficit needs to be reduced, and government debt kept at a reasonable level relative to GDP. State and local governments have the same problem, plus the federal government continues to download fiscal burdens to the states. If spending on government health and retirement programs cannot be curtailed, there is no hope of getting federal deficits and debt under control. The present value of all federal entitlement programs is $60-80 trillion versus GDP of $15 trillion in 2012. The programs are not sustainable, especially with the 76 million baby-boomers reaching retirement age and living longer than expected.

Politicians have refused to take any action to solve some of these problems. The fiscal cliff looms ahead. Nothing certainly will be done before the Nov. 6 election, but come January 2013, the Bush tax cuts could expire in combination with massive spending cuts at the federal level. The combination of tax increases and spending cuts could push the U.S. economy off a cliff into recession. Hopefully Congress and the president can put away their partisanship and ideological purity to take actions to prevent the cliff scenario.

The Chinese economy has slowed, not so much by government economic statistics, but by more measurable statistics such as electricity usage, exports and imports of material resources. Global economic weakness and inflation have eroded China’s cost advantages in exports, the main prop of China’s economy. It will make a big difference whether China’s economy will experience a soft landing or a hard landing.

Confidence plays a big role – perhaps a self-fulfilling one – in influencing economic growth. While consumer confidence has perked up recently, they still appear to be affected by the trauma of the financial crisis, the decline of home and stock prices, unemployment, government bailouts, and political uncertainty. Given the depth of the trauma, it may take time for consumer confidence to fully recover. This has certainly been reflected in the stock market. While the S&P 500 has more than doubled in value since the March 2009 lows, investors have withdrawn nearly $500 billion from U.S. stocks during that period, and the trend continues.

Corporate confidence and investment play a big role in economic growth, and right now confidence among U.S. chief executives has reached a three-year low, according to a recent survey by the Business Roundtable. The end result being that corporations are sitting on $2 trillion of cash and not making the capital expenditures needed for economic growth. Corporations face the same uncertainties listed earlier, plus the possibility of new regulations, Obamacare, slowing export markets, and a host of others. It will take sustainable economic growth for them to regain their animal spirits and invest the cash sitting on the sidelines.

The Fed has been extraordinarily aggressive in its monetary policy since the financial crisis and recession. Short-term and long-term interest rates are at historical lows. The Fed has also implemented quantitative easing, QE1, QE2 and QE3, as well as Operation Twist. QE1 and QE2 resulted in the Fed purchasing more than $2 trillion of U.S. government securities and mortgage-backed securities. Operation Twist resulted in the lengthening of the duration of the Fed’s bond portfolio. While QE1 and QE2 had definite upper bounds in the amount of bonds to be purchased, QE3 is opened ended in that the Fed will purchase $40 billion of mortgage-backed securities each month until the employment market improves. The QEs have taken the Fed in directions never taken before. Risks abound, especially the possibility of higher inflation because of the massive amounts of liquidity pumped into the economy and the risk of exit if and when inflation picks up. There is now $2 trillion to $4 trillion of excess liquidity available and where it goes could have good or bad consequences for the U.S. economy.

To quote Donald Rumsfeld, the U.S. Secretary of Defense in 2002, “There are known knowns – there are things we know that we know. There are known unknowns – there are things we now know we don’t know. But there are also unknown unknowns – there are things we do not know we don’t know.”

It appears the world economy today is dominated more by the unknown unknowns. But uncertainty doesn’t always mean downside. There could be an upside to all of the problems and challenges facing the U.S. economy. So  things may not turn out as bad as expected. While the U.S. has been experiencing the slow growth scenario lately, there are some economic positives. Both U.S. manufacturing and service sectors have shown positive growth recently, U.S. home prices have increased 6.9 percent over the first six months of 2012, stock prices are up 14.6 percent over the first three quarters of 2012, corporate earnings, while growth has slowed, have held up in the slow-growth economy, and the U.S. is becoming more self-sufficient in energy.

But the bottom line is that it’s probably wise to be cautious until some of these uncertainties become more predictable and/or resolved. While uncertainty creates both risk and opportunity, it may be better to emphasize safety over aggressiveness in the foreseeable future. There could also be some event not listed above or predictable that could impact investment results. We live and invest in interesting but uncertain times. More things can happen than will happen. But that is what uncertainty is all about.

Why Macro Isn’t Macro

The obsession today besides Gangnam Style and kimchi hotdogs is figuring out why the US economy does not operate on all cylinders. Many of us have been moaning about too much stimulus from the Fed and the government. Others defend stimulus as if it came down from a mountain on a stone tablet. It occurred to me that there is another way to explain why monetary and fiscal stimuli are at once ineffective, impotent, and wasteful. No I am not talking about any of my relatives.

The problem is that macro isn’t always macro. If you apply a macro remedy to a non-macro problem then you are not heading in the right direction. Sort of like having a heart problem and the doctor takes out your liver. It doesn’t make much sense right?

So let’s dig into what macro means – macroeconomics that is. No offense to macrobiology or macrobiotics or macrophilia. Let’s use an example. Suppose we have an athletic team with 5 members who average 150 pounds (for you non-Americans that’s roughly 700 kilos). One of the team members quits and is replaced by a new team member who weighs 300 pounds. If the guy who left weighed near the average it is pretty obvious from my exciting and colorful example that the average weight of the team has now increased substantially. So the coach weighs the team and exclaims – “this team weighs too much – we must do something about it.” So the coach tells each player to lose 30 pounds. Does that make sense? If the entire reason the team weighs more is because of this one new player – why don’t you do something about that? Just fire that player and hire one that weighs 150 pounds. That sounds more logical – the coach has confused the average weight of the team with the reason the team got heavier.

This example is making me hungry. So let’s get back to macroeconomics. The economy of any country is incredibly complex. One day you buy a house the next day you buy a bottle of JD. One day you buy a roundtrip ticket to Ellettsville and the next day you buy a JD with Coke at the Uptown Cafe. One day you receive a stock dividend from the Jack Daniels Company. Aside from JD the economy produces a lot of different things. When someone asks how the economy is doing – we don’t spend hours describing the changing outputs of each and every one of these things. We usually refer instead to how much is left in your gallon bottle of JD. No – that is silly. You call up your friendly macroeconomist and say – Larry what is going on with GDP? You see, Gross Domestic Product is a measure of how much stuff (stuff is a very technical term I use in graduate macro classes to define all the crap measured in GDP) a country produces.

GDP is macro! In 2011 USA GDP totaled about $15 trillion. Imagine all that stuff piled up in front of you. If GDP increases to $16 trillion in 2012 then we will say something like – Holy Smokes Petula – our nation produced more in 2012 than 2011. Let’s celebrate with a little JD. We say this because you actually know someone named Petula and because you identify a nation’s output  as GDP. You then start imagining about all the wonderful things that we produced – more t-shirts that say dumb things, a bigger harvest of tomatoes, more automatic weapons, a bunch of cool tattoos, and on and on. You can imagine the quantities of most things we buy increasing more or less in proportion to GDP’s increase.

But the truth is that the increases and decreases are not usually so equally proportioned among the different kinds of goods and services. The truth is that in some years much of the increase is services to consumers. In another year much of the increase is computers and other equipment used by businesses. This is normal. But in some years the changes can be VERY unequal. Imagine in one year that all of the $1 trillion increase was JD. Or instead the entire increase came from Viagra. You see what I mean? Your interpretation of what is happening to national output might not be correct. If you don’t approve of Tennessee sour mash or little blue pills, then upon learning that the increase in GDP of $1 trillion was all bottles of JD or Viagra, you might be less approving. You might worry about the producers of all those other goods and services. The $1 trillion increase might not look so beneficial.

This is very much what is happening in the USA now. The situation now has to do with the less-than-spectacular performance of the national economy. I put some numbers together below to try to convince you that the performance of the national economy or the changes in GDP have been dominated by one or two parts of the overall economy. Mistaking the problem of a few sectors as a national or macro problem is like worrying in the above example that the average weight of the team is too high. Yes the weight was too high but not because each team member was too heavy. The remedy should fit the problem. If the problem with GDP is focused in a few sectors, then broad brush fiscal and monetary policies that are meant to revive the entire economy are going to be inefficient and impotent.

So let me turn to the actual numbers. These numbers are the published figures for real GDP for the USA – where real means that the impact of inflation has been removed and the numbers reflect only output or volume changes. These are standard numbers published by the Bureau of Economic Analysis at www.bea.gov

The last US recession started at the beginning of 2008 and lasted for most of two years – 2008 and 2009. Real GDP contracted at a rate of about -1.7% per year. In the two years that followed the recession the economy recovered growing at an average rate (over 2010 and 2011) of about 2.1% per year. The economy seems to be growing at a slower pace than that in 2012. So over three years of recovery let’s suppose the annual growth rate turns out to be a little less than 2%. People look at that number and compare it to past recoveries and find the current experience to be very disappointing. The slow employment growth and stubbornly high unemployment rate support this disappointment.

This disappointment leads our policymakers to want to raise the amount of stimulus. They want to spur on spending in the national economy. They lament middle class people who are unable to buy enough goods and service. They worry about teachers and police who cannot buy enough and therefore firms do not produce more. But this is a very misleading picture. What I do below is compare the growth rates of major national spending categories during the two years of the recovery (2010 and 2011) to the growth rates prevailing in the two years prior to the beginning of the recession (2006 and 2007):

           

                                    Annual Average Growth Rate

                                          2006-2007      2010-2011
Consumer Durable goods           4.8                   6.4
Consumer Non-durable goods    2.3                   2.3
Consumer Services                     2.3                   1.5

Business Equipment                    5.5                10.0

Exports                                      9.2                   8.9

Imports                                      4.3                   8.7
Federal government defense       1.9                 0.2

Federal government non-defense 1.2                2.3

State and local government         1.2                2.6                

_______________________________________________________________

From the above table it is not easy to see why the macro economy is stalling. Many of these categories are growing stronger after than before the recession started. While it is true that state and local government, federal defense spending, and consumer services have not helped, take a gander at the two categories I purposely left out:

                              Annual Average Growth Rate

                              2006-2007             2010-2011

Business structures       11.8                     -6.5

Residential investment -13.0                     -2.6

These two categories of real GDP comprise the real estate part of national output. With respect to business structures we see a very strong pre-recession sector that has still not turned positive. Focusing on the demand for new houses for families we see that the problems started well before the recession. If there is a sector that appears to be the leading indicator or the cause of what was to come – it is residential investment. It was contracting at double-digit rates BEFORE the recession started – and it continues to contract.

It is true that we had a national recession in the US during 2008 and 2009. But as we look at the past 6 years and try to decide on policy in 2012 and 2013 – it seems pretty clear that we do not have a macro problem today. The recession started with real estate and it ended with real estate. And real estate continues to plague us.  Most of the other categories are growing plus or minus at about their pre-recession rates. As such this is not the time for general stimulus – a policy aimed at expanding spending in all categories of spending would be both wasteful and dangerous. Why stimulate sectors that have recovered?

If real estate is really the issue, then why don’t policymakers focus their policy energy on the real issue? Maybe I should leave it there. The current policies are tantamount to making all the players on the team lose 30 pounds. What do you think? These policymakers have access to this same data. Why do they waste our time and money on policies that won’t work? Why don’t they spend more time dealing with what actually caused our current mess?

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.