Pointing a Finger at Currency Manipulators

President Obama famously said that he wanted to increase the export sales of the US  -- he said he wanted to double their value between 2010 and 2015. In July of 2010 I wrote about this and among other things I likened this doubling to something like the US basketball team scoring 200 points per game in an international competition. I will show below that based on two years of experience, it appears to be even less likely the US will double exports. I bring this up not so much to gloat but so as to head off what appears to be right around the corner – a vigorous attempt by Obama’s administration to paint other countries as exchange rate manipulators and international cheats. It is no secret that the dollar has been rising against the yen and euro – and that portends the usual finger pointing. I try to explain why that approach won’t help matters at all and could make the international trade situation worse. What our government won’t say is that the dollar has been depreciating for many years now and remains a shadow of its former self. If any country has used currency depreciation to its advantage, it is the USA.

Let’s get to the trade data first. I used standard GDP data from the US Bureau of Economic Analysis. http://bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=128&904=1999&905=2012&906=A

As in my last post on this subject, I use trade data that is in the real terms – that is, the figures have filtered out any price change. In 2010 US exports of goods and services in real terms equaled about $1.67 trillion. In 2012 they had increased to $1.84 trillion, an increase of about 10%. But to put it into a longer term perspective, US exports were $1.19 trillion in 2000. This means that despite a weakening currency it took 12 years for exports of goods and services measured in real terms to increase by 55%. If we ignore the exports of services and just focus on merchandise, the story is similar. US exports of goods in 2012 were $1.54 trillion increasing by about 20% since 2010 and by about 96% since 2000. Exports of goods took 12 years to almost double and increased by about 20% in the last two years. So how can Obama expect to double them again in five years? It is not possible.

Let’s not hold the President to a 100% gain in five years – let’s just see what it might take to keep the champagne flowing for a while. During the last two years the US dollar fell. It fell against the currencies of Canada, China, and Japan but it rose against the euro. The trade-weighted value of the dollar fell by about 10% in those years. Thus, the large improvement in US exports of the last two years seems to have been aided by a depreciating dollar against many foreign currencies (except the euro).

But that information does not in any way establish a strong link between exchange rates and trade results. A look back at the dollar since 1999 shows the dollar has depreciated even more. The trade weighted dollar continuously declined against the world’s major currencies during the time from 2002 to 2012. It declined in those 10 years by more than 20%.  The dollar declined even more against the Japanese yen, Chinese renminbi, and Canadian dollar. The dollar fell against the euro by approximately 50% during those 10 years and despite some recent appreciation of the dollar against the euro, the dollar is still almost 20% below the euro’s beginning value and some 30% below its value in 2002.

As our government starts pointing its finger at China and other countries as currency manipulators, it will do well to understand a few further points. What matters to a country is its net exports – not it exports. Net exports are defined as exports minus imports. For example, if exports double next year while imports triple, the net impact of exports AND imports on spending and employment would be negative. So while we are doing cheers for export growth, what do we know about imports? If we measure from 2010 we find that US goods and services imports measured in real terms increased by 7% and since 2000 by 37%. As a result the US net export balance improved modestly from $-451 billion in 2000 to -$420 billion in 2010 and to -$402 billion in 2012.  So while this key balance has improved we could say it improved by about 4% in two years and by about 11% in 12 years. That’s not much improvement given all the currency depreciation we have witnessed.

Why didn’t we do better than that? What can the President do to make exports AND net exports improve more quickly in this country? The answer is that it isn’t easy. Lasting trade improvements come from durable and real improvements in global competitiveness. Exports will rise and imports will fall if the people of the world increasingly want US goods and services. What makes our goods attractive beyond the current exchange rate? For one thing it helps if our trading partners are strong and growing. We should hope that Europe, China, Japan and other key trading partners find good ways to exit the world slowdown and grow more rapidly. The more they grow, the more they will buy from us. 

But we also must have the best goods and services at the best prices. We need an economic environment that makes firms freer to compete globally. While that involves breaking down foreign barriers it also means having clearer and more supportive regulations as they relate to business activities and costs. The current environment in the US is not conducive to major industry investments in competitiveness. Policy uncertainty is rife with respect to national debt, Fed stimulus, energy, banking, health, and much more. "Depreciating" government regulations would do much more right now for our trade balance than would depreciating our currency!

President Obama could greatly improve our trade performance and that would be an important source of economic growth. But he needs it to be a major and clear objective –not just a talking point. Free trade agreements with Pacific and European counterparts would help but are no more than hot air given the President’s clearly expressed desires to support environmental and union demands. Clearing up uncertainty about federal government business regulation sounds good but there is little evidence of any real focus there. It will be a lot easier for Obama to point his finger at currency manipulators and shift the blame elsewhere. Does that sounds familiar?

Velocity, Kleenex, and Drugs

I had a cold last week. I blew my nose so many times that the stock of Kimberly-Clark Corporation increased by 10%. I also took some pills. The pills sometimes work for me but I must have waited too late – as the waterfall from my nose kept up for at least three days. Anyway, as my cold was appearing to diminish I wondered if I should stop taking the pills. It is a dicey situation – if you stop taking the pills your cold continues and maybe even worsens. If you continue taking them and you are really on the mend – it dries you out so badly that it starts a dry cough that sometimes makes you even sicker. The Fed is in a similar situation and I believe the Fed is about to give us all a major dry cough. Below I try to explain why something called monetary velocity is at the heart of the Fed’s dilemma.

According to the popular M2 measurement of money, the value of the money supply increased from $7.3 trillion in 2007 to over $10 trillion in 2012. The increase was about 38%.  More striking is the performance of something called bank reserves – something the Fed has more direct control over. Reserves went from $94 billion in 2007 to $1.6 trillion in 2012. What the Fed intentionally injected into the system increased by 17 times.

This is not news – but it does quantify two things – the Fed was extremely active in injecting money and the result is a lot more money in the financial system. Ordinarily this kind of aggressive stimulus administered in a recession does the following – reduce interest rates, increase bank borrowing, increase spending, and subsequently increase output and employment. In the case of 2007 to 2012, we are all frustrated that the monetary expansion did not have a larger impact on output and employment. Fed Chairman Bernanke and most of his advisors want to continue the stimulus. In a recent speech Bernanke intimated that the Fed (1) despite an economic recovery that begin in 2010 would not begin to remove the money from the system and (2) would not sell government bonds from its portfolio, simply allowing those bonds to mature. What do these two statements mean?

In Forbes the title of a recent article was “Fed’s Balance Sheet Swells to a Massive $2.9 trillion on Treasury Buys.”  I wish my balance sheet would swell a little too! That was in 2011 – now the balance sheet is up to $4 trillion. But this does not mean that the Fed is wealthier. It just means that it has created money (recall the $10 trillion M2 referred to above) by buying Federal government bonds from the public.  That is the usual way the Fed increases the money supply – it buys the bonds we hold and sends us money that we deposit into our bank accounts. It is a cool system. So long as there are a lot of government bonds out there – and as long as we are willing to sell them, the Fed has a great way to inject money into the system. And yes – the Fed can do this at will – they do not need any gold or any silver or permission from Nancy Pelosi to do this kind of thing.

When Bernanke says he will not sell any part of those $4 trillion of bonds he holds – he is saying that he is not going to take money out of the system. Note that when the Fed sells its holding of government bonds – they send the public a bond and you and I send money to the Fed. When the Fed sells bonds – money in the system decreases. Not selling the bonds means Bernanke will not take money out of the system. So the stimulus remains.

When Bernanke says he is going to hold those bonds until they expire or mature the plot thickens (sickens?). When the bonds expire, the Treasury will pay the holder of the bonds the face value on the bonds. Aha – so the Fed gets even richer! No it doesn’t because the Fed turns around and gives the money back to the government. In the first place the government does not have enough money to really give it to the Fed (unless it borrows even more). In the second place, the Fed is not allowed by law to get rich.

Notice that the government originally owed both interest and principal to the public. So when the Fed bought all these government bonds – the government essentially got to skate. That is, the Fed’s purchasing these bonds means the Treasury has reduced the interest and principal effectively owed by the government. The Fed bailed out the government with its monetary policy. This is what people call monetization of debt. It is tantamount to the Fed printing money so the government can spend more than it collects in tax revenue.

So basically what Bernanke is saying today is – we are bankrolling the government and we are going to continue doing it. And that gets me back to my cold and the pill dilemma. Bernanke is doing this because he is afraid that if he stops supporting the government, the economy will fail. He could not handle the Twitter buzz if the economy fails. But if the patient is really on the mend, then failing to withdraw the drug could cause some real complications or what I referred to last week as Unintended Complications.

My liberal friends say tone it down Larry – there is no inflation anywhere. Why are you so worried – all that money isn’t hurting a fly? Not true.  First, there is inflation and it is growing. But that was my point two weeks ago. This week I am making a different point and it has to do with a concept called monetary velocity (V).

I won’t go into the equations and all the technical mumbo jumbo, but let’s define something called the BAM (Bang Associated with Money). BAM tells you the potential impact of money on spending. BAM is the joint result of two things – (1) the amount of money times its (2) circulation or V. Look at the dollar bill in your pocket. That is part of M2. You have it now but when you spend it the hair stylist gets it. Then he spends it at the liquor store. That dollar bill may get used quite a few times during the year. Thus $1 of M2 supports a lot more than $1 of spending. How much more spending – how much more BAM – depends on both M2 and on V.  

BAM = M2 times V.

We know what happened to M2 between 2007 and 2012. It increased dramatically. But what about V? V equaled about 1.93 in 2007. It has been declining ever since. As of the end of 2012 it was about 1.54. That is a reduction of V of about 20%. Recall that M2 increased by 38%. So you might say that the BAM factor increased by about 18% (= 38% - 20%) between 2007 and 2012. So while the money supply might have been hoping for a BAM impact of 38% -- we didn’t get that much impact because V fell. M2 increased but V decreased. So BAM increased by 18%. As a result the monetary impact on output and employment was a lot less than the Fed hoped. That’s the past, what about the future?

What many people are worried about is that V will not stay down forever. The V being down is very much related to uncertainty about the future. It is very much determined by banks that are reluctant to lend money – and by people who are paying down their personal debts to get into better financial condition. But what happens if the economy keeps improving and at some point confidence surges? What happens if the Fed does not remove any M2 but V goes back to a more normal number? Instead of BAM equaling 18% today it could jump to 38%! It would equal 38% at a time when we no longer need stimulus!

In one way that sounds good. We will finally get some oomph in the economy. But keep in mind that this 20% increase of BAM will get distributed between output and inflation. For example – if BAM increases by 20% this year – we could get any of the following possibilities:

o   Output goes up by 20% and inflation increases by 0%

o   Output goes up by 10% and inflation increases by 10%

o   Output goes up by 0% and inflation increases by 20%.

Even in an extraordinary year national output would not go up by more than 6-8%. Can we handle an inflation rate of 12-14%? I don’t think so. That is a very sore throat! Bernanke says he won’t reduce M2 but so long as M2 remains high everything depends on the future course of V. Maybe it will not bounce back to 1.9 anytime soon. But clearly V is going to return to something more typical as the economy approaches normalcy. Leaving M2 fixed is a sure way to make sure that inflation becomes a major future economic problem. Of course so long as the Federal government does not deal with its long-term fiscal crisis there is enormous pressure on the Fed to keep monetizing the debt. A coordinated movement away from both monetary and fiscal policy is necessary for a stable economic future. Monetary policy needs to be reversed but we will not see this until the government joins the process. Our President says debt is not a major problem today. I totally disagree. 

Managing Unintended Consequences

We all know about Unintended Consequences (UC). Say it out loud – UC.  For those of you whose native language is not English you should pronounce UC a little like the word duck or muck, but without the d or the m. It is not a pretty sound and UC is not a pretty topic. But if you ask me UC is the place that liberals, conservatives, and other people might find some common ground.

Liberals often categorize conservatives as selfish people who represent the interests of wealthy individuals and businesses. Conservatives view liberals as people who like to stand for worthy causes especially when it involves using other people’s money. These descriptions probably fit some liberals and conservatives but most of the ones I know cannot be so easily stereotyped.

Most US liberals and conservatives grew up in similar schools and churches and pretty much buy into mainstream culture and philosophy. It would be hard to find many who disagree with the so-called golden rule – do unto others as you would have others do unto you. I don’t know how many stories and movies revolve around a character being aided unexpectedly and then sometime in the future repaying the kindness.

Liberals and conservatives share many such cultural values. But clearly it is not hard to find times when they disagree and often passionately. In recent days some liberals have championed policies which would increase taxes paid by rich people. Some conservatives responded by saying that we wouldn’t need to tax rich people so much if some people asked for less in the way of unearned entitlements. Liberals ask for gun control laws to protect our children and conservatives retort that such laws are ineffective and take away fundamental rights. The disagreements go on and on.

These disagreements exist despite a lot of share values. We often debate for good reasons. For example, liberals and conservatives disagree about the fundamental nature of man. A conservative sees people as fundamentally fixed while liberals believe society can change people. Conservatives are wont to engage in change while liberals persist in a belief that changing external circumstances can lead to better social outcomes.

So there is plenty of reason for liberals and conservatives to disagree even though they might seek the same outcome. Part of this can be explained by UC.  We are all familiar with UC. I was trying to mix a Manhattan and by accident I poured gin instead of bourbon. Yuk. You and your girlfriend wanted to end the evening in an enjoyable way and nine months later there were three of you. You get the picture, UC.

Professor Philip Adler at Georgia Tech introduced a lot of us to UC in the 1960s under the banner of bubble management. He told us that management is like a big balloon. He likened the solution to a management problem to pushing your finger into a bubble that formed on the surface of the balloon.. Adler warned that EVERY TIME you push your finger into the bubble on a fully inflated balloon it creates another bubble somewhere else on the surface of the balloon. It is a little like Newton’s Law of Motion III – to every action there is always an equal and opposite reaction. Good management means making the resulting bubble in the balloon smaller than the initial one.

So UC is always with us. You have to manage those bubbles. The main reason we have such big issues in Washington these days is that many of those people there have Law Degrees and never studied with Dr. Adler.  Managing UC means you always worry that your policy becomes counterproductive. Companies say they manage risk. What does that mean? It means UC. It means that in the course of deciding to build a new plant in Budapest they begin with a clear statement of all the good reasons why one would like to build a plant in that location. 

But you don’t stop there. Someone then says – what could go wrong? Is it possible that there are negatives that we have not fully accounted for? Even after you build the plant you keep asking this question. If the government changes and it imposes harsh penalties on foreign firms then maybe it is time to close that factory or move it to Bloomington.  Parents do the same thing all the time with their kids. Jimmy wants a BB gun. Mom says, you will shoot your eye out. But mom I am 45 years old now. Nevermind.

Liberalism or Progressivism or whatever you want to call it has promoted and continues to advance and expand the application of government solutions. Many of their goals are honorable. But the problem is that UC has been put on the back burner. If Samsung is willing to incorporate contingency planning then why is government so reluctant to admit UC?  There are many reasons but clearly the providers of government services often become the promoters of it. They become the cheerleaders. A harsh program evaluation could mean loss of a job for the government worker. Or the government worker might simply believe that more is always better. That worker might not zealously look for UC. Governments don’t measure profits to indicate the success or failure of a new program so it is harder to quantitatively evaluate UC. Often the simple metric that shows that more people are being served suffices to "prove" the validity of the program. Of course there is also the simple fact that it is much easier to give new benefits than it is to take them away in a democracy.

No matter what the reason we leave the measurement, analysis, and discussion of UC to the other guys or we kick them down the road for another time. The more the conservatives complain about UC the more the liberals dig in their heels. Thus the issue of good government management becomes a fight instead of a collaborative effort to improve the lives of citizens. Some people laughingly would say that good government management is a non sequitur. Good government is impossible.

Imagine if someone had the nerve to say any of these things in public…

·        More lenient abortion laws cause more unwanted pregnancies
·        Increasing the minimum wage helps very few poor people and increases unemployment of teens
·        Poverty programs reduce the desire to be independent and self-supporting
·        Alternative energy is bad for the economy because it is too costly
·        Illegal aliens create social burdens
·        Tax loopholes make the rich richer

Anyone who ventured such statements at a cocktail party might get slugged by an otherwise sweet and caring grandmother. Our liberals and conservatives have turned discussion into fights. Hot words set off other hotter words and possibly a few punches.  But everyone knows that all those statements have some truth to them. 

Everyone knows that every policy has an UC. The real question is not whether or not they exist – the question is how large and how important they are.

We have had plenty of experience with government programs. We have seen both the benefits and the UC of programs to reduce unwanted pregnancies, reduce poverty, promote alternative energy, improve healthcare, make Americans more secure at home and abroad, and so on. Today we are faced with large national debts and no one wants to spend or tax needlessly. Gutting good programs makes no sense. Taxing people more for programs that do not succeed only hurt the country.

I am not so naïve as to think that comparing prospective benefits with the UC of a government program is easy or definitive. But I do know that what we have been doing lately can only lead to worse outcomes for all of us. Most people agree that the current sequester was never meant to happen because it is so onerous and wrong. The fact that the House has been passing legislation that has no chance of passing in the Senate and the Senate passes nothing means that we make our mistakes permanent. Surely we can make all of our government programs more effective. Surely we can cut waste. 

Companies do this all the time. They hire and fire; they restructure; they hire new marketing consultants; they cut costs to meet new competition. Yet our government will not even discuss the effectiveness of trillions of dollars of programs. Voters and their representatives need to think like Professor Phil Adler – push in that balloon and expect something negative to happen. But make that UC as small as possible so that you get the very most bang from the tax buck. 

Inflation, Unemployment, and Bonnie & Clyde

One of the most frequently discussed indicators of a country’s economic well being is inflation, yet I am finding that hardly any two people would agree on its definition much less its measurement. It is sort of like sex. Remember when a past US president said he did not have sex with that woman? Perhaps according to some definitions of sex he didn’t but we all knew he did something that sounded like sex. No matter how you define inflation – seems to me it is on its way but it is not too late to head it off at the pass.

Wikipedia uses the following words in a paragraph about inflation, “general rise in the level of prices of goods and services… erosion in the purchasing power of money… the loss of real value in the internal medium of exchange.”

In March of 2013 why should you care about inflation? For one thing, when the price level of goods and services is rising, you care. No one loves paying more for beer and pork rinds at the 7/11. But alas, beer and pork rinds are only a part of what I buy and who knows what you buy? That is, when prices of beer and pork rinds increase, the impact on you could be very different than the impact on me. And that gets us back to some seemingly innocuous words in the definition – “general price level.” In this case “general” is referring to someone but if your name isn’t General, then one wonders what that means. Another reason we care about inflation relates to policy. Our Fed and our government is telling us that since inflation is so low presently we ought to have a policy that stimulates spending enough so that inflation goes back to a more normal level. This policy of stimulation will have many impacts on us through its effects on prices, interest rates, employment and more. But I will get back to this second point below.

A general price level is something that you and I will never experience. That is because it is a mathematical expression or an equation. The general price level of goods and services averages together the prices that we pay for goods and services. A general price level for the USA then is based on some average person’s purchases. That “average person” is not me and it is not you. It is the average of me, you, Paul Krugman, Peter Wachtel and a lot of other people. So if you eat Peter Pan peanut butter seven times a day, then your own personal price level is going to be quite different from the general price level. If this month found that peanut butter prices fell by 20% you might be happy as a clam about your price level even while the nation’s price level was increasing and making most people frown.

To make things even more complicated, there is not just one general price level. There is a very broad national price level called the GDP Price Deflator that averages together the prices of all final goods and services bought by consumers, businesses, governments, the foreign sector, and inter-planetary travelers. It not only includes the prices of peanut butter, beer, and pork rinds, but also the steel purchased by manufacturing companies, and the tanks purchased by the defense department. A more popular and commonly used level of prices in the US is the consumer price index or the CPI.  But the CPI has several versions. One applies to urban consumers while a different one is focused on urban wage earners. Apparently urban workers and urban consumers do not buy the same things in the same proportions.   These are both called an “all items” index because they are measuring the prices of all the goods and services that urban consumers and/or workers buy. The list includes goods in the following categories: food, beverages, housing, apparel, transportation, medical care, recreation, education, communication, and others. Let’s agree – that’s a mountain of stuff being averaged together each month!

In December of 2012 the CPI all items index for urban consumers had a value of about 230. In December of 2011 its value was 226. Looking at this all items CPI index you would conclude that the general level of prices in the USA rose in 2012. From that one comparison you do not know which prices went up because the overall increase is a result of averaging together changes in the prices of food, beverages, housing, etc. If you use go to the Bureau of Labor Statistics Website (http://data.bls.gov/cgi-bin/surveymost?cu ) you will find a lot of data and you can try to figure out which of those categories of goods and services contributed most to the rise in the general level of prices.

It turns out that there are two categories of the all items index that are bad actors. These two categories are the Bonnie and Clyde components of price indexes. Food and Energy (F&E) misbehave frequently. They stay out late and then sleep it off in the morning. While the prices of all the other categories of goods and services typically rise and fall more or less together from month to month and year to year – F&E prices tend to leap around like jack rabbits. You just never know which direction they are going to move and by how much. Because F&E behave this way, they have to go to timeout. 

No just kidding but it is almost true. Because they behave so erratically we have another price index called the All Items Less F&E for All Urban Consumers.

You are frowning because you understand that removing F&E prices makes this index less comprehensive and representative. And you would be right. But keep in mind that a general price index is supposed to be telling us about the thrust of all goods and services. An index containing food and energy is misleading for three reasons. First, the F&E swings the all-items index and misrepresents the movements in the other goods and services categories. Second, because F&E changes are so erratic from month to month – they misrepresent the general direction of prices. For example, because of food and energy prices we saw dramatic swings in the all items index – 4% increase in 2008, -0.5 % decrease in 2009 and then a 3% increase in 2011. Meanwhile the all items less food and energy showed some variability but hugged an average of about 1.8% per year.   Most prices were growing at a little less than 2% per year. The All items index showed a very different and extreme pattern – a very misleading pattern of the general thrust of the prices of most things you buy. Third, when F&E prices swing wildly we often react and change our purchasing patterns. When F&E prices are rising rapidly we find ways to reduce our purchases of these items and that reduces the impacts on us in ways that are not captured in the all items index.

In early 2013 we are wondering where future inflation is headed. If we look at the All items CPI index we see a blur of upward and downward movements dominated by F&E price changes over the last 10 years with no clear direction. If instead we look at the all items CPI less F&E we see what looks like a wave rising and falling gently over time. After showing a declining inflation rate from about 2006 to 2010, this inflation rate has been trending upward – measuring about 2% in 2012 but portending future increases in the coming years. 

This gets us back to government policy. Our national goal is to bring the unemployment rate down. Policy stimulus is one way to do that but it has great risks. If the stimulus leads to more inflation then it sets off all kinds of alarm bells that are very bad for employment. With the inflation rate rising in a growing economy, it is not hard to predict that continued stimulus will increase current inflation and expectations about future inflation. We learned in the past that stimulus raises interest rates, oil and other commodity prices, increases wages and other business costs, and generally creates adverse conditions for output and employment growth. Inflation might be in the 2% range today but all indications are that the best way to reduce the unemployment rate is to have less stimulus and lower inflation.

Bernanke’s Retirement, the Lottery, and Casper the Friendly Ghost

Young Ben had planned on saving for his retirement. But alas, each time he got close to putting a few bucks into his saving account something came up. One time it was Aunt Barb’s lobotomy – another it was Jason’s need for a new ant farm. But Ben was not afraid and he boldly told everyone that his retirement income was already in the bag. After a few JD’s Ben would loudly explain his plan. Upon his 65^th birthday he would retire and promptly play the Indiana State Lottery and win upwards of $50,000,000. Surely $50 million would be enough to provide for his retirement years.

That sounds pretty silly doesn’t it? But this is almost exactly what Ben Bernanke and the press are saying about monetary policy. Last week a few members of the FOMC were brazen enough to question when the Fed might begin pulling out some of the zillions of dollars of reserves they pumped into the economy the last five years. Has it really been five years Martha? Wasn’t the recession over in 2009?

Anyway, you would have thought that Oliver had asked for more porridge. The markets had heart attacks and TV anchors gazed at all of us with anguished faces. Pull out the money??? We can’t pull out the money with France in a dither and with US unemployment at 8%! Ben agrees and he assures us that he will know exactly when to pull out all that money. And he will do it in a painless and happy way. Hey guys did you hear that Ben pulled out the money and no one even noticed it. Man that Ben is like the best eco-money surgeon.  He can pull trillions of dollars out of the system without anyone even realizing it. He is better than Casper the friendly ghost.

So what is going on here? Why is Ben Bernanke waiting to begin pulling the money plug? The answer is that it is like Jason’s Ant Farm. When faced with a decision to disappoint your child or save money for retirement, many people’s hearts are tugged. Ben looks around and sees a lot of unemployed workers and he realizes that the second he announces a policy to withdraw monetary stimulus, interest rates will rise and jeopardize spending and economic expansion and along with it employment. Surely when you compare that scenario to waiting a while to remove the money, it seems more humane to leave the money in the system.

So why do his colleagues on the FOMC want to start withdrawing stimulus now? Are they hard-hearted fiends and vampires? Perhaps, but I think not.  They want to help unemployed workers too but like waiting until the last minute to win the lottery to support you in old age – these Fed officials believe that it is better for the Fed to start the process now – instead of later. It is probably true that an announcement to reverse the course of policy of the last five years would result in a rational forecast that interest rates will rise. That expectation alone can start interest rates rising immediately. That doesn’t sound good. But keep in mind that short-term interest rates are basically zero right now. EVERYONE knows this is a temporary situation. The only real question is when they will rise and by how much.

Okay – so rates are going to rise back to something more normal. But how much will they rise? Expectations will drive rates up as soon as the announcement is made. But then what?  First, notice that a policy to begin removing money when there is a ton of it out there might not disturb money and credit markets very much. That is, banks are sitting on so much money that they have plenty of it around for quite a while. Markets will not immediately find money scarce. So this excess supply should help to slow and hold down interest rate increases. Second, the economy is not exactly roaring right now. When the economy surges ahead, this often creates soaring demand for credit that can cause large increases in interest rates. Without a rapid increase in US or global demand, we should not expect much pressure for interest rates to rise. Third, much has to do with inflationary expectations. That is, whenever we think inflation is going to rise in the future, these increases are mirrored in interest rates.  The reason for pulling out the money today is to reduce expectations of future inflation.  So a policy to begin gradually removing monetary stimulus ought to begin an orderly increase to normal levels of interest rates – but one that won’t necessarily reduce economic growth and employment gains.

The bigger risk comes from waiting. By waiting the Fed continues its stimulation of the economy and encourages bubbles. These bubbles are already impacting many prices and encouraging increased financial risk taking. These bubbles raise our expectations for inflation and raise the demand for money as a response to the increase risk and uncertainty generated by not knowing when the policies will change.  We increasingly encourage hostility from our trading partners as our surplus money seeks overseas opportunities and reduces the competitiveness of their exports.

Of course the timing problem is exacerbated by the Federal government who seems unable to control future budget deficits. This means credit markets will have to digest $1 trillion or more government bonds each year for the foreseeable future. Normally interest rates would rise as private firms sell bonds that compete with the government for precious private saving. The Fed’s aggressive purchasing of government bonds make it possible for the government to finance its deficits without driving up interest rates. Thus an expansionary monetary policy seems necessary to fund an expansionary fiscal policy. If the government continues on this path it puts upward pressure on interest rates. Clearly a reversal of both fiscal and monetary policies is what we need right now.  

The Fed’s decision to ease up would be very much aided by a prudent fiscal policy. But with or without the proper fiscal change, the Fed does us all a favor by doing the right thing and starting that right now.  Waiting risks another bubble and another explosion. 

Debt and Safe-Haven Status

Today we are faced with government debates about the importance of managing national debt. The President’s State of the Union Address did not show a strong movement towards debt reduction. Those of us who worry that growing debt can and will lead to another economic crisis in the US often point toward US fiscal policy performance relative to that of other countries. By any measure, the US has acquired a much larger federal debt in the last several years since the economic crisis began. As recent examples in Greece, Spain, and Italy show – investor worries about debt repayment can spike interest rates, cause rapid outflows of foreign investment, and harm values in equity and other markets.

Those who prefer a very slow approach to debt reduction in the US often point to recent low interest rates, a rising stock market, marginal inflation, and other key macroeconomic indicators as evidence that the US can continue to carry very large debt loads without an investor backlash. But that view is very risky and myopic. The future very much depends on the so-called “safe-haven” allure of a country’s assets and currency. The US and Japan have benefited greatly from being safe-havens. But notice how these reputations can easily erode. Japan’s recent announcements of more vigorous fiscal and monetary stimulus have caused major depreciations in the yen and promise further contractions in asset values.

My blog posting today examines how the US is doing relative to 10 selected countries when it comes to dealing with debt issues. The below Table comes from theIMF (International Monetary Fund’s World Economic Outlook, October 2012. http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/tblpartb.pdf ) and summarizes why I believe the US is ready to follow Japan. The last table column (Management) shows that the US joins only Spain and Japan as countries that have shown no real movement toward national debt management. I have labeled seven countries as having strong management – meaning that since their national debts peaked during the crisis these seven governments have dramatically reduced fiscal stimulus. These are the comparison countries when future investors think about the best and safest places to invest. Below I go into some detail behind the construction of the table.

It is very clear that the US is risking its safe-haven status when so many other countries are moving away from stimulus. One might argue that the so-called “austerity of these seven countries has led to weaker growth and therefore risks a government-induced double dip. But the evidence is not strong on that score. It is true the unemployment rates in Greece and Spain continue to rise but notice that these are two very different cases. Greece’s structural deficit is forecast (See table column 2012) to be lower than its Best (Table Column 1) – while Spain’s has been reduced from its Peak but remains some 5 times larger than its Best value before the crisis. Notice also that Germany and Canada – two countries having strong debt management are expected by the IMF to see significantly lower unemployment rates in 2012 and beyond.The US with strong stimulus continues to struggle with high unemployment. 

  Structural Government Deficits, Percentage of Potential GDP  

                                Best*    Peak      Ratio     2012       Management

Greece                      8.7          18.6        2.1          4.5          Strong

UK                           4.7            9.7        2.1          5.4          Strong

Italy                          3.3            3.6         1.2         0.6          Strong

USA                         2.7            8.7         3.2         6.8          No

Euro area                  2.3            4.4         1.9         2.1          Strong

France                      2.2            4.7         2.1         2.8          Strong

Japan                        2.2            7.9         3.4         9.1          No

Germany                   1.1            2.3         2.1         0.5          Strong

Spain                        1.1            9.0         8.2         5.4          Weak

Canada                     0.5            4.1         8.2         2.9          Strong

Netherlands             (0.1)           4.3          na         2.4          Weak

*Best is the government structural deficit from before the financial crisis in either 2005, 2006 or 2007

Peaks came in 2008, 2009, or 2010. Ratio is Peak divided by Best.

2012 is the projected value for 2012 (projected by the IMF as of October 2012)

Management refers to the relationship between IMF structural debt projection for 2012 and the previous Best

A structural government deficit (surplus) is meant to measure the amount of purposeful stimulus coming from that nation’s fiscal policy. It is not the same as the published government deficit figures we usually see. For example, in this table’s first column, the USA deficit of 2.7% of potential GDP means government was intentionally adding stimulus in 2006. The unemployment rate in 2006 was 4.6% -- very close to full employment. So there was little need for stimulus and the structural deficit of 2.7% is pretty small though larger than most of the countries in the Table.

From the countries I selected – the structural deficits are all pretty small before the crisis – except for Greece with 8.7%. Notice that Canada and the Netherlands had pretty close to balance – suggesting near-zero stimulus. Germany and Spain were not far behind.

As the financial crisis and global recession took full force in 2008 and 2009, budget deficits moved automatically larger. I say automatically because we know that when employment decreases and incomes fall – this leads to less revenues flowing into government and more spending on unemployment benefits and other social programs. That is – without any change in legislation or policy – government deficits get larger in recessions. The data table does NOT measure those automatic changes.

During recessions governments believe they must go beyond the automatic stabilizers and do something proactive to stimulate spending, incomes, and employment. The changes we see in the Table are intended policy changes to expand the economy. We see that in the US the structural deficit went from 2.7% to 8.7% of potential GDP. That is, the US structural deficit more than tripled. Of the 10 countries compared to the USA:

·         Japan’s deficit also tripled.

·         Only four countries had a larger Peak deficit than the USA – Greece, the UK, Japan, and Spain

·         Six had a doubling or less of their structural deficits from Best to Peak.

·         Of those six Greece started with a very high deficit.

·         Spain and Canada saw an eightfold increase – though Canada’s came from a very low Best deficit.  The Netherlands had an experience similar to Canada.

Clearly the US was among the countries providing the most intended fiscal stimulus during the crisis. The US is also not among the countries removing that stimulus post-crisis and our leaders seem satisfied with little to no debt management. Should we continue to lead from behind we risk loss of our safe-haven status. Stimulus has not stoked the fires of economic recovery and will only make things worse. It is high time to think of sounder ways to promote stronger growth and higher employment. 

Is Government the Problem?

Progressives or liberals believe that through collective action government is the solution – that is it is necessary to reach national goals. President Reagan countered that government is the problem. So which is it…The Problem or the Solution? And why does answering that question matter?

My answer is that it is a false question. It is sort of like having your mother-in-law living with you. She is there for the foreseeable future. If you let her, she will solve some of your problems while creating others. But she is there and you better figure out how to live with her. She isn’t going anywhere!

Government is like that. You would have an easier time getting your mother-in-law to move out than getting rid of your government. In the USA the government is a big mother. It spends a lot of money, it taxes, and it regulates. It is not going to move down the block. It is a waste of time arguing about whether it is the solution or the problem -- when it is both. The more important question is how to make it better.

Let’s start with a decision rule that applies to any institution. The government should solve problem X if (1) the private sector cannot solve X and (2) the government sector can solve X with reasonable efficiency. For example, let X be cancer. The private sector has not been able to eradicate cancer. So should the government try? While criteria (1) is satisfied many of us would wonder why it is that government could do a better job than scientists in pharmaceutical and biotech companies. Thus a government cancer program might not survive criteria (2).

Contrast this case to the famous case of the company emitting pollutants in a stream that another company uses in its production process. The very dirty water creates costs for this second firm who has to filter the water before using it. In the absence of any government pollution programs, the down-stream firm has costs that are not of their own making. Thus the costs and price of the downstream firm are made higher while the upstream firm has no liability. Thus a problem exists that is not solved by the market system. Enter the government. A pollution tax could be levied on the polluter that is in proportion to the costs incurred by the second firm. Thus government pollution regulation might be a solution for this problem if it reduces the amount of the pollution. This looks like a strong case for government action. 

Of course, much depends on whether the government would apply the correct solution. If the government simply closes the first plant or creates a pollution tax totally out of proportion to the harm – then society might be worse off with the government action.

Why do we care about these two decision rules? We care because it makes no sense to have a government that makes things worse. There are many problems out there. There are many ways these problems can be handled by the private sector. But in some cases, the private sector cannot get the job done. But just because the private sector can’t solve the problem does not mean the government should. Sometimes living with a problem might be better than solving it. Back to the cancer example. Cancer is a stubborn disease. Suppose a government official promises to spend $15 trillion per year to solve cancer? Government is going to raise taxes by $15 trillion per year to accomplish this? You would note that $15 trillion is about the size of the incomes earned by all Americans in one year. That’s a national cancer program that would be destructive. We can’t afford it.

You might say that our government officials are nice people and they would never intentionally waste the people’s money in this way. But then you would be forgetting many things about government. The first thing is that governments are as fallible as are the people who run them. For example, they might spend more on a problem than they initially intended because of human error.  Such a cost over-run in a private firm shows up in lower profits and will get attention quickly. But in government there is not such strong feedback loop for cost over-runs. There are no quarterly profit reports and no stockholders to get annoyed. In government a tally at the end of the year of all spending and taxes might find the government with an unexpected government deficit. At some point the voters might show their displeasure with this but nowadays that seems like a pretty slow and faulty system for cost over-runs.

Second, government officials answer to voters. We might even say that they cater to voters. Voters like the idea that government can provide them with things and they know that a benefit for them will be paid for by the country. If I want my street to be safer it is nice to think that the whole country will help me pay for that safer street. Unfortunately there is a fallacy of composition. If everyone wants a safer street they can’t have one. It would cost too much. So government creates a big problem for the politicians. They want everyone to know that the government is there to help so that they will get votes. But they know they can’t help everyone. This creates a queue for more government spending and a continual demand by voters for more government. It makes no sense for any single household to not participate in the demand for government growth. You are going to pay for it so you will want to get your share of the benefits.

The point is not to say that government is bad. The point is to show that once you set up a government and have it go about solving problems, then you have to be very careful or it will cost and grow more than expected. It takes strong vigilance. It is no accident that most economic calamities and pain often comes after rapid increases in government spending. It is also no accident that restraints on government spending, taxation, and debt are commonplace and that such restraints are often the advice handed to governments experiencing subpar economic activity. The Congressional Budget Office in the USA, the World Bank, the International Monetary Fund, and the Organization  for Economic Growth and Development are just a few of the policy advising bodies that regularly counsel counties to be careful about government growth.

Reagan was right when he looked back at the 1960s and 1970s and said government was the problem. But liberals are also right when they say that government can and should be the solution to pollution, poverty, security, and many other national problems. If they are both right then it shows that there is no free lunch when it comes to decisions about government spending and growth. It means that serious people in and out of government need to decide on the currently correct amount of government – program by program. This is about solving our problems with solutions that don’t bankrupt the country. It is about solving real problems based on real analysis and not on short-term vote getting. Isn’t it amazing when you watch our political leaders how far they are from this kind of rational behavior? 

No More Takers

Being economically conservative, it surprises me that conservatives have not been more effective politically. It seems to me that conservatives have a very strong case today but it somehow doesn’t win. I think I know why. It has to do with the word “takers.”

First, winning elections is not mainly about demographics. It is true that we have more people voting who are not white middle age males. But any voting group you can mention is not a homogeneous block. Each group has its liberals, conservatives, and centrists. Obama lost votes in 2010 because he lost centrists. He won more votes in 2012 because he won centrists. In my opinion, Republicans have not forever lost these centrists. They do not have to give up their principles in order to attract them back to Republican candidates and policies. But they do have to change their approach.

Second, conservatives need to give up on this “takers” thing. Hey Joe Taker – you are a selfish meathead. By the way, please vote for me. Really? Calling 47% of them names and then asking them to vote for you? An entitlement is government spending going to a person because a law specifies that that person is eligible for government assistance.  

You don’t have to be a wild and crazy liberal to believe that government help is good for the country. One entitlement is the social security benefit. Most of us who receive this benefit believe we “earned” it by dutifully paying payroll taxes to the US government for half a century – despite the fact that social security is not an insurance program.  We are “takers” in the sense that we receive assistance from the government – but we are NOT takers in the pejorative sense said or implied by some conservatives.

Social security benefits are not a plot to rob the rich, but that does not mean that we cannot discuss and criticize social security. Perhaps we can raise the age of eligibility. Perhaps we can make it more progressive. Maybe we can make it work better. Such critical analysis would be beneficial for social security – and for all government entitlements. The government, like any other organization, is far from being perfect. A poverty benefit might go to a family that has temporary economic problems. They need to be tided over. That seems very reasonable to me. I wouldn’t brand such a family a “taker”.  But a poverty program that somehow creates more poverty rather than less through poor administration or poorly designed incentives – ought to be reformed. Poverty programs should create less poverty – not more.  They should help people escape poverty not be imprisoned by it.

My point is that the whole “takers” issue needs to be ended and replaced with one that is less sensational and more correct. EVERY government spending program and every tax source needs to be reconsidered for reform. Is it crazy and dangerous to admit that government programs can create perverse incentives that lead to unnecessary and damaging government spending growth? Do we not have plenty of data from the last 75 years to show which programs have been successful and which have not? Republicans, it seems to me, have plenty of ammo in that data. They can focus on all those cases where policy has failed to succeed. They can focus on all the examples of unintended consequences. They can focus on the facts and how the facts show that policies have failed.

The third point is once they have pointed out the failures of too much government growth, they can explain the conservative case for improving social outcomes and government services. We are not going to get rid of a government that spends $4 trillion annually. But Republicans can show that they have BETTER policies – better ways to solve the problems of pensions, healthcare, poverty, energy, immigration, and so on. The focus is SOLVING problems. Reagan is famous because he said government was the problem and he explained how slower government growth could solve our national problems. Today’s Republicans need to speak with a clear and powerful voice.

Republican solutions often stem from very different assumptions about human behavior and about how government can impact those behaviors. There is nothing mean or selfish about teaching a person how to fish. There is nothing mean or selfish in pointing out how some programs have done just the opposite. Self-confidence is a great goal. Liberals often point out that self-confidence can be generated or restored though government entitlements. But sometimes these entitlements do the very opposite when they reduce the incentive to go beyond government payments.

This is not about takers. It is about the best way to use government to solve national problems. Conservatives have nothing to be ashamed of – they just need to quit pointing fingers at takers and explain why conservative remedies and less growth in government are the best ways to help people.

Some conservatives will react to the above by saying the game is over. They repeat the idea that the takers are now in the majority. Once in the majority it seems there is no end or limit to how much more they can take from the richer minority. But the data for this assumption is weak. As I said above all the so-called groups of takers include many centrists. These people understand that too much selfish taking hurts the country and often hurts the very people who receive the government benefits. But these centrists will vote for people who appear to have the best solutions. Obama and the Democrats wooed them in 2012. I think Obama’s case is weak and grows weaker each day. But it is the Republicans who must make their case now. They must stop calling people names and get down to the mundane business of showing vividly how and why government programs must be reformed so that we have an effective social state that pays for itself and attempts to solve mankind’s most pressing problems.

Final note. The Wall Street Journal is a library of data, case studies and other forms of evidence that reveal countless failures of government as well as positive advice on alternative solutions. But the WSJ and other similar outlets do not have the same reach as the many more liberal paper and electronic media outlets. Republicans need to find new and better ways to summarize, condense, or otherwise package all this great research and information and disseminate it to a larger public. Quit talking about takers and quit looking down at our people. Let’s raise our collective consciousness about a better way to run this country.

The Fed -- Too Little Too Late

What happens when you bring too little too late?  For example, you arrive at the party with only a thimble full of JD. Everyone else has peaked and there you are sober as a judge and all the really cool girls are taken. You might as well retire to the library. You could try to “catch-up” quickly but you know how that will end up. That is the way it is with too little too late. All the good options are gone.

So why do people do this kind of behavior? For one thing, maybe we are clueless. Some of us don’t see a problem or opportunity coming until it runs right into us. Garsh honey, after being married for 28 years I didn’t know you had blue eyes. Anyway, a second reason for coming with too little too late is that you are just basically conservative. You NEVER strike first or fast. You prefer to see how things play out. 

Finally there are those people who assess each problem independently. Sometimes you address the issue quickly – like when your daughter brought home that guy with the really loud motorcycle. Other times you believe a more patient approach is best.

So too little too late can occur for many different reasons. I am thinking about this after Ben Bernanke was quoted last week as saying that while he noticed that his low interest rate policy is creating financial bubbles, he doesn’t see any reason to change his policy. 

His speeches make one pretty sure that important people like Federal Reserve Chairmen are studying problems judiciously and coming to very good decisions. But it is worth wondering out loud whether he is either clueless or inflicted by a habit that ALWAYS waits too long to make the right decision.

A recent report quoted in the press was very critical about Fed Policy in 2007 – faced with a slowdown in the economy, the Fed seemed to be the last one to know that a recession was taking place and needed a boost. Of course just before that the Fed was faced with about-to-explode bubbles in real estate and financial markets and closed it eyes to anything they might do about all this. Inasmuch the Fed went from a policy to stimulate the economy quickly to one that slowed it and then back to a policy to stimulate the economy. Wow – now that is frying pan to the fire kind of stuff. The Fed seemed to be the last one to know that a change in policy was needed.

Of course none of this is new. As inflation built during the 1960s and then early 1970s it seemed to take forever for the Fed to react. By the early 1970s the Fed had to jerk the economy around – so much that they finally had to give up for fear of creating an economic crisis. They admitted failure to control inflation when after being the backbone of the Gold Exchange Standard for almost 30 years, the USA unilaterally backed out of that system. Then Nixon, realizing the Fed could not solve the economic problem talked privately to his own portrait several times and decided to implement Wage and Price Controls. Of course that didn’t work. The main effect of W&P Controls was that a 50 cent candy bar was soon a lot smaller and still cost 50 cents. Apparently the W&P Controls didn’t differentiate between price and price per ounce. Lovers of Baby Ruth bars went into the streets and rioted.

We weren’t finished with inflation – it kept escalating throughout the 1970s – until the Fed finally got serious – after doing too little too late they followed that with too much too late in 1980. Remember the stories of 20% interest rates? Those are not fun stories. It pretty much wrecked us for a while.

This history shows why the Fed ought to be on top of their policies. If Bernanke is seeing bubbles forming then he would do us all a huge favor by taking out a really big and sharp needle and popping those suckers. Do it right now. Why doesn’t he do that? I don’t think he is clueless. I don’t think he needs to study this problem. I think he has a wait and see syndrome. But how much more evidence does he need? Hey mom – I see bear droppings on the front porch. I am scared. Don’t worry honey – there are no bears around here. The Ranger told me so.

Bernanke does not want to upset the applecart. The right policy now is to admit that it is time to end the low interest rate policy. But Bernanke isn't when the bubbles will burst. He doesn't want to do anything to anger investors or bankers right now. We can deal with the aftermath of the bubbles if they ever pop on their own. The Democratic Party is saying the same thing about debt relief. Paul Krugman said we can take care of exploding debt in 2030. The government can be counted on to do too little about bubbles because of politics. 

That is understandable. But the Fed is legally independent of the President and Congress. The Fed does NOT have to support expansionary policy. The Fed is supposedly run by apolitical technocrats. Or did the last financial crisis change that? Has the Fed become a lackey to politicians bent on endless stimulus? I hope not. Too little too late will bring another round of too much too late. And of course another recession. 

Timeout For Lucy

The Debt Ceiling is Scarier Than the Fiscal Cliff was Alan Blinder’s latest contribution to macro policy (WSJ page A17, January 15, 2013). I guess he never read Snoopy and witnessed how Lucy routinely pulled the ball away as Charlie Brown tried to kick it. Now he wants to scare Charlie enough so that he takes one more kick at a vanishing ball. The Republicans have apparently agreed to pass a debt ceiling increase but Lucy is still at work and needs to go to time-out for a while.

Blinder spends the whole article explaining all the horrible things that might happen if the debt limit is not lifted. I admit it is pretty scary stuff although I think he doth exaggerate. We all know the debt limit will be lifted – it is just a question of how long it takes to reach a compromise. Our government is clever enough to juggle the spending for a month or two without really throwing old folks over the cliff. I love the way Blinder and other Democrats keep bringing up how Social Security and Military pay checks might be delayed because recalcitrant, hard-hearted, mean, selfish Republicans won’t lift the ceiling. The President could arrange that kind of evil spending priority but it would be only for political purposes – he and Congress have many other options for spending changes that would be less onerous on a temporary basis.

Blinder mentions how world investors and ratings agencies will downgrade and flee US assets because of a failure to reset the debt ceiling another trillion dollars or more to cover the planned deficit this year. He worries the US would be technically bankrupt. Of course, nothing could be more false. The US has plenty of money and an unshakeable obligation to pay interest to its creditors…more spooky scare tactics by Blinder and his friends. He knows but won’t admit that those creditors could care less about the debt ceiling – what they care about is getting paid back. What matters for creditors is the size of future deficits and growth of the debt. The extra trillion we need now is just a down payment on future increases in the debt that arise because government will not agree on a program to manage the debt. A credible medium- or long-term fiscal program is all that matters. That is what the ratings agencies want to see. That is what the creditors want. Raising the debt ceiling is like me promising to fit into my wedding suit by asking for one more slice of pie.

What is silly is that these scare tactics are so obviously political and so wrong that most people completely write them off as puffery. We all know that the Democrats want one more chance to pull the ball away from Charlie. The Democrats wanted a tax increase on the rich and they got one – as well as a sizeable increase on everyone on a payroll. Now they want more tax increases on the rich. What happened to all that talk in the last year about a comprehensive tax reform and spending restraint? What happened to entitlement reform? “No Charlie – I promise not to pull the football away this time. Take a big whack at the ball.”

The unfortunate message from the Democrats is that they are proving they cannot be trusted to enact anything that comes close to deficit/debt moderation. Higher taxes on the rich won’t do anything beyond nibbling around the edges of the budget pie. Ignoring a broad tax reform and arguing loudly against entitlement reform sends an even stronger signal to ratings agencies and creditors that we are not serious about controlling our debt.

I was once critical of both parties but when I read Blinder’s scare tactics it made me want to point the finger of blame in one direction. Democrats and their mouth pieces must stop holding our country hostage to their unflinching goals of income redistribution and unfettered spending growth. They have to stop these stupid scare tactics and sit down with Charlie Brown and do the hard business of putting our country on a stable financial path. 

Age of Aquarius is over – Put some clothes on

Comments I received after my last blog confirm what I have been sensing since the last US presidential election – people are losing interest in analysis. It is not possible to summarize all the facets of this loss but a common thread is that we are in an age or a cycle that appears to be strengthening – and that stage or cycle is one that seems to be on auto-pilot. 

Thus attempts to argue or reason against it are virtually useless. That some Democrats stress that winning the election gives them the right to move on with their agenda of change just reinforces these feelings of inevitability. 

This posting is meant to address this seeming loss of hope amongst those who do not agree with the policies of the Democrats. I am a little more optimistic than some of these worried folks and I believe my optimism is supported by history. But I have to admit, it is not easy as a macroeconomist to watch the current experiment. It reminds me of looking back at the early 1970s and the Nixon Wage and Price Controls. 

Everyone knew they would fail – the only question was when they would end and how much damage they would cause. Instituted in August 1971 they were finally abandoned in 1974 as prices continued their escalation through 1980. Nixon, a conservative economist was mystified by the newly coined macroeconomic disease – Stagflation – and he lost faith in traditional macro and opted to try something new and different. (By the way I coined the term Infession at the time but apparently my status as a graduate student did not allow my terminology to rival the more popular term stagflation.)

Today our government is tormented again by a new disease – this time it is a housing and financial crisis that led to a deep recession of six quarters followed by a very slow and weak recovery period. Our policy makers responded with a strong dose of traditional Keynesian stimulus – a coordinated fiscal and monetary expansion that injected trillions of dollars into the economy. At the onset of the recession in 2008 it seemed reasonable to support a housing/financial intermediation with a strong Keynesian spending impulse.  But we are now many years beyond the beginning and the end of the last recession and the Keynesians are not ready to throw in the towel. The reluctance to ditch continued stimulus seems shared in many important places including Japan, Switzerland, Great Britain and others.  The European Central Bank joins our Federal Reserve in a pledge to do what is necessary to keep spending growing.  Both have acknowledged risking higher debt and inflation for the sake of short-term economic stimulus.

It may be surprising to many of you that some monetarists support the use of a Keynesian stimulus in the short-run.  Some monetarists accept much of the Keynesian model as it relates to the short-run. But monetarists and other non-Keynesians distinguish themselves when they disagree with Keynes’ statement that we are all “dead in the long-run.” This was Keynes’ way of saying that all that matters is the here and now. Non-Keynesians, however, think we need to worry more about the future. Many non-Keynesians might agree to the stimulus in 2008 and 2009 yet object strongly to continuing such a policy beyond the worst of the recession.

And that is where we find ourselves in 2013. Keynesians believe that austerity or a policy to even gradually remove stimulus today would be tantamount to pulling the proverbial rug out from under the economy.  They don’t even want to talk about it. It is like global warming. If a person challenges conclusions from weather data they are branded immediately as either ignorant or falsely motivated. And those are the nice names. Someone who worries today about future debt or inflation is not considered to be serious. In this environment it is no wonder that people don’t want to analyze or argue.

So let me turn away from the specifics of the debate and explain why history makes me somewhat optimistic. I think we are rapidly nearing the end of an age of government growth. You will scoff at this prediction because you see no end to government growth but it is often just when things look like they will never change that they do. I am not predicting that the government will vanish but I do see signs that the share of government in the economy will stabilize and decrease.

Who could imagine the Soviet Union falling when it did? At one time it seemed impossible that the German advances before World War II could be stopped. Before coal was discovered European wood was rapidly being depleted with the usual consequences on energy and transportation costs. At one time all the South American countries were run by dictators who promised a future with a closed, self-reliant economy. Much of Africa was once run by European colonials and much of the population was in slavery. The Age of Aquarius as depicted in the musical Hair promised a change in values that had its day but petered out...or else we'd all be wearing tie-died clothing.  History suggests that times do change. Sometimes when they seem the blackest is when they are closest to change.

And that makes sense. Because when times seem the worst is when it becomes more and more difficult to tell the same old untruths. The story of the emperor who wore no clothes was written for an important reason. People will go along with things so as to not disturb the leaders. In that story it was child who said the obvious – noting that the emperor was as naked as a blue jay. And then EVERYONE agreed to that reality. Clearly the emperor needed some new duds.

In the case of government growth and current macro policy it won’t take that much longer to see the failures. We have had about 75 years of this age and while I have no desire to go back to the 1930s it is clear that the government process needs a lot of oversight and improvement. The gem of the government process – Social Security – is nothing like what was promised.  Young adults worry that this protection will not exist for them when they retire. The cost of Medicare and Medicaid grew by multiples of original cost estimates. The War on Poverty has done almost nothing to eliminate poverty and some might say that it has institutionalized it. Obamacare is just getting started and one can predict that it will not fulfill some of its most important promises as the economy tries to digest its thousands of pages of new regulations. An article I read this week projects private healthcare policies doubling in price as early as 2014. They will likely be called traitors by our current government. 

Already there is visible proof that neither the government nor the central bank knows how to reverse what were supposed to be temporary stimulus programs. The end of the temporary decrease in payroll taxes in 2013 is causing the US economy to slow even further this year. The politicians promise to reverse engines at just the right moment but we all know that the date is coming closer and closer when we will have violent reactions to rising inflation, interest rates, and national debt.

I probably left out a lot of the writing on the wall – but the more important part of this story is that the average voter is going to soon feel the negative impacts of the end of the Age of Government Growth. We know the rich cannot and will not support the present and future growth. No amount of make-up applied to smiling political faces will be able to mask the impacts on the middle class. Their incomes will be taxed away and inflation will eat at their earnings. The next government financial crisis will make it impossible for young people to save anything for the future as their 401Ks shrink in value. Young workers will feel hemmed in without future prospects. Government programs will be less affordable and the world will no longer lend money to the US government. Government programs will have to be seriously scrutinized. People will be heard saying – why didn’t we see this coming? Why did we let this go so far? We have had major government deficits ever since the 1960s! 

The average person will come to understand through personal experience that while it sounds good for government to help them – it often is not their best alternative. Somehow the government kept this deception going for nearly a century.

So let’s keep arguing. Let’s keep making the case for unintended consequences. Let’s be specific about why stimulus is not always the answer. Let’s keep reminding people why piling up national debt is self-defeating.  Let's keep explaining how and why more conservative policies, though not perfect, are often better than knee-jerk government solutions. The Age of Aquarius is over. So is the age of rapid government growth! Somebody please put some clothes on Nancy Pelosi!