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Preview: RealClearPolitics - Articles - Robert Samuelson

RealClearPolitics - Articles - Robert Samuelson

Last Build Date: Mon, 13 Apr 2009 00:50:00 -0600

Copyright: Copyright 2009

Obama's Economic Mirage

Mon, 13 Apr 2009 00:50:00 -0600

What Obama proposes is a "post-material economy." He would de-emphasize the production of ever-more private goods and services, harnessing the economy to achieve broad social goals. In the process, he sets aside the standard logic of economic progress. Since the dawn of the Industrial Age, this has been simple: produce more with less. ("Productivity," in economic jargon.) Mass markets developed for clothes, cars, computers and much more because declining costs expanded production. Living standards rose. By contrast, the logic of the "post-material economy" is just the opposite: spend more and get less. Consider global warming. The centerpiece of Obama's agenda is a "cap-and-trade" program. This would be, in effect, a tax on fossil fuels (oil, coal, natural gas). The idea is to raise their prices so that households and businesses use less or switch to costlier "alternative" energy sources such as solar. In general, we would spend more on energy and get less of it. The story for health care is similar, though the cause is different. We spend more and more for it (now 21 percent of personal consumption, says Brookings economist Gary Burtless) and get, it seems, less and less gain in improved health. This is largely the result of costly new technologies and the unintended consequence of open-ended insurance reimbursement that encourages unneeded tests, procedures and visits to doctors. Expanding health insurance might aggravate the problem. Many of today's uninsured get health care free or don't need much because they're young (40 percent are between 18 and 34). Together, health care and energy constitute about a quarter of the U.S. economy. If their costs increase, they will crowd out other spending. The president's policies might, as he says, create high-paying "green" or medical jobs. But if so, they will destroy old jobs elsewhere. Think about it. If you spend more for gasoline or electricity -- or for health insurance premiums -- then you spend less on other things, from meals out to home repair. Jobs in those sectors suffer. The prospect is that energy and health costs may rise without creating much gain in material benefits. That's not economic "progress." To rebate households' higher energy costs (as some suggest) with tax cuts does not solve the problem of squeezed incomes. Given today's huge and unsustainable budget deficits, some other tax would have to be raised or some other program cut. And collective benefits? What defines the "post-material economy" is a growing willingness to sacrifice money income for psychic income -- "feeling good." Some people may gladly pay higher energy prices if they think they're "saving the planet" from global warming. Some may accept higher taxes if they think they're improving the health or education of the poor. Unfortunately, these psychic benefits may be based on fantasies. What if U.S. cuts in greenhouse gases are offset by Chinese increases? What if more health insurance produces only modest gains in people's health? Obama and his allies have glossed over these questions. They've left the impression that somehow magical technological breakthroughs will produce clean energy that is also cheap. Perhaps that will happen; it hasn't yet. They've talked so often about the need to control wasteful health spending that they've implied they've actually found a way of doing so. Perhaps they will, but they haven't yet. We cannot build a productive economy on the foundations of health care and "green" energy. These programs would create burdens for many, benefits for some. Indeed, their weaknesses may feed on each other, as higher health spending requires more taxes that are satisfied by stiffer terms for "cap-and-trade." We clearly need changes in these areas: ways to check wasteful health spending and promote efficient energy use. I have long advocated a gasoline tax on national security grounds. But Obama's vision for economic renewal is mostly a self-serving mirage.[...]

A Global Free-For-All?

Mon, 06 Apr 2009 00:30:00 -0600

It may surprise Americans that, up to a point, his analysis is correct. The dollarized world economy developed huge instabilities -- vast trade imbalances (American deficits, Asian surpluses) and massive, offsetting international money flows. But Zhou's omissions are equally revealing. To wit: China is heavily implicated in the dollar system's failings. By keeping its currency artificially depressed -- as an aid to exports -- China abetted the very imbalances that it now criticizes. The Chinese denounce American profligacy after promoting it and profiting from it. Low prices of imported goods (shoes, computers, TVs) encouraged overconsumption. From 2000 to 2008, the U.S. trade deficit with China ballooned from $84 billion to $266 billion. China's foreign exchange reserves are now an astounding $2 trillion. It's not just that exchange rates were (and are) misaligned. American economists have argued that a flood tide of Chinese money, earned from those bulging trade surpluses, depressed interest rates on U.S. Treasury securities and sent investors searching for higher yields elsewhere. That expanded the demand for riskier securities, including subprime mortgages, and pumped up the housing bubble. So China's policies contributed to the original financial crisis, though they were not the only cause. For decades, dollars have lubricated global prosperity. They're used to price major commodities -- oil, wheat, copper -- and to conduct most trade. Countries such as Thailand and South Korea use dollars for more than 80 percent of their exports. The dollar also serves as the major currency for cross-border investments by governments and the private sector. Indeed, governments hold almost two-thirds of their $6.7 trillion in foreign exchange reserves in dollars. But overreliance on the dollar can also backfire, as it now has. Not only have countries suffered declines in exports to a slumping U.S. economy. They've also lost dollar loans needed to finance trade with third countries. "When the crisis hit, U.S. banks cut back on dollar credit lines to foreign borrowers," says David Hu of the International Investment Group. The extra loans endorsed at last week's summit aim to offset these losses. Given the dollar's drawbacks, why not switch to something else, as Zhou suggests? The trouble, as even he concedes, is that there's no obvious replacement. The attraction of an international currency depends on its presumed stability, what it will buy and how easy it is to invest. The euro (27 percent of government reserves) and the yen (3 percent) don't yet rival the dollar. As for China, it hasn't made its own currency (the renminbi, or RMB) automatically convertible for Chinese investments. We're stuck with the dollar standard for a while. To work, it requires that countries with huge trade surpluses reduce the export-led growth that fed the system's instabilities. The Chinese increasingly recognize this. "They're very aware of the need to promote consumer spending," says economist Pieter Bottelier of Johns Hopkins University. In November, China announced a 4 trillion RMB ($586 billion) "stimulus." In addition, says Bottelier, the government is improving health and pension benefits to dampen households' need for high savings. But China also has a default position: promote exports. It has increased export rebates; engaged in RMB currency "swaps" with trading partners (the latest: $10 billion with Argentina) to stimulate demand for Chinese goods; and stopped the RMB's slow appreciation. China seems comfortable advancing its economy at other countries' expense. Zhou's pronouncement provides a political rationale for predatory behavior: If we're innocent victims of U.S. economic mismanagement, then we're entitled to do whatever is necessary to insulate ourselves from the fallout. Down this path lies growing mistrust. The world economy is suspended between the lofty rhetoric of last week's summit and the gritty realities of national politics. Protectionism is[...]

Uncle Sam's Hedge Fund

Mon, 30 Mar 2009 00:00:00 -0600

But succeed or fail, Geithner's plan illuminates a fascinating irony. "Leverage" -- borrowing -- helped create this mess. Now it's expected to get us out. How can this be? It's not as crazy as it sounds. Start with the basics on how leverage affects investment returns.

Suppose you bought a stock or bond for $100 in cash. If the price rises to $110, you make 10 percent. Not bad. Now, assume that you borrowed $90 of the purchase price at a 5 percent interest rate. Over a year, the stock or bond still increases to $110, but now you've made more than 50 percent. You pay $4.50 in interest and pocket a $5.50 gain on your $10 investment. Note, however, that if the price fell to $95, you'd be virtually wiped out ($4.50 in interest paid plus $5 lost on the security).

Economist John Geanakoplos of Yale University argues that the economy regularly experiences "leverage cycles." When credit is easy, down payment terms are loose. Investors or homeowners can borrow much of the purchase prices of houses and securities. Prices of assets (stocks, bonds, real estate) rise, often to artificial levels because investment returns are so attractive. But when credit tightens -- government policy shifts or lenders get nervous -- the process reverses. Prices crash. Leveraged investors sell to repay loans. New borrowers face stiff down payment terms.

To Geanakoplos, we're suffering the harshest leverage cycle since World War II. Three years ago, he says, homebuyers could put down 5 percent or less. Now they've got to advance 20 percent or more. Hedge funds, private equity funds and investment banks could often borrow 90 percent of security purchases; now borrowing can be 10 percent or less. "Deleveraging" has caused prices to plunge to lows that may be as unrealistic as previous highs.

Grasping this, you can understand the idea behind Geithner's hedge fund. It is to inject more leverage into the economy -- not to previous giddy levels but enough to reverse the panic-driven price collapse. Details remain unsettled, but the plan would allow 6-1 leverage ratios in some cases. Here's an example. Private investors put up $5; the Treasury matches that with another $5. This equity investment could then be expanded by $60 of government-guaranteed loans. The entire $70 could be used to buy assets from banks.

Sounds simple. In practice, it won't be. Given all the deleveraging -- a record 15 percent of hedge funds closed last year -- the market prices of many securities have been driven well below prices that seem justified by long-term cash flows. Geanakoplos mentions one mortgage bond whose market value has dropped by roughly 40 percent even though all promised payments have been made and, based on the performance of the underlying mortgage borrowers, seem likely to continue.

If banks sold this and similar credits at today's market prices, they would have to record huge losses. ("Banks Face Big Writedowns in Toxic Asset Plan," headlined the Financial Times.) Their capital would be depleted and they'd have to raise more or request more from government. Presumably, the government-supplied leverage would enable investors to pay higher prices. After all, that's the purpose. Still, whether sellers and buyers ultimately agree on prices is unclear.

If they can't, Geithner's hedge fund will remain puny. Cautious banks will continue to constrict credit. But success also poses problems. Money managers talk about making huge annual returns of 20 percent or more from a scheme in which government puts up most of the funds and takes most of the risk. A political backlash might squash the project before it starts. Geithner treads a narrow line between financial paralysis and populist resentment.

Can American Capitalism Survive?

Mon, 23 Mar 2009 00:20:00 -0600

Almost everything about Schumpeter's diagnosis rings true with the glaring exception of his conclusion. American capitalism has flourished despite being subjected to repeated restrictions by disgruntled legislators. Consider the transformation. In 1889, there was no anti-trust law (1890), no corporate income tax (1909), no Securities and Exchange Commission (1934) and no Environmental Protection Agency (1970). We have subordinated unrestrained profit-seeking to other values. "We've gradually taken into account the external effects (of business) and brought them under control," says economist Robert Frank of Cornell University. External costs include: worker injuries from industrial accidents; monopoly power; financial manipulation; pollution. Great reform waves often proceed from scandals and hard times. The first discredits business; the second raises a clamor for action. Parallels with the past are eerie. "No one in 1928 thought that the head of the New York Stock Exchange would end up in Sing Sing (prison) in 1938," says historian Richard Tedlow of the Harvard Business School. That was Richard Whitney, convicted of defrauding his clients. Flash forward: Bernie Madoff, once head of NASDAQ and also a member of the financial establishment, goes to the slammer, a confessed swindler. Some guesses about capitalism's evolution seem plausible. The financial industry -- banks, investment banks, hedge funds -- will shrink in significance. Regulation will tighten; required capital will rise. Profitability will fall. (Until recently, finance represented 30 percent or more of corporate profits, up from about 20 percent in the late 1970s.) More of the best and brightest will go elsewhere. But Schumpeter's question remains. Will capitalism lose its vitality? Successful capitalism presupposes three conditions: first, the legitimacy of the profit motive -- the ability to do well, even fabulously; second, widespread markets that mediate success and failure; and finally, a legal and political system that, aside from establishing property and contractual rights, also creates public acceptance. Note that the last condition modifies the first two, because government can --through taxes, laws and regulations -- weaken the profit motive and interfere with markets. The central reason why Schumpeter's prophecy remains unfulfilled is that U.S. capitalism -- not just companies, but a broader political process -- is enormously adaptable. It adjusts to evolving public values while maintaining adequate private incentives. Meanwhile, the ambitious, striving character of American society supports an entrepreneurial culture and work ethic -- capitalism's building blocks. As for new regulations, many don't depress profitability because costs are passed along to consumers in higher prices. It's also wrong to pit government as always oppressing business. Just the opposite often holds. Government boosts business. Some New Deal reforms helped "by making risk more manageable," says Stanford historian David Kennedy. Deposit insurance ended old-fashioned bank panics. Mortgage guarantees aided a post-World War II housing boom. Homeownership skyrocketed from 44 percent in 1940 to 62 percent in 1960. Earlier, the federal government distributed 131 million acres of land grants from 1850 to 1872 to encourage railroads. Land, as well as bank charters and government contracts, often went to the well-connected. Cronyism is sometimes capitalism's first cousin. Still, the present populist backlash may not end well. The parade of big companies to Washington for rescues, as well as the high-profile examples of unvarnished greed, has spawned understandable anger that could veer into destructive retribution. Congressmen love extravagant and televised displays of self-righteous indignation. The AIG hearing last week often seemed a political gang beating. If companies need to be rescued from "the market," then why shouldn't Washington [...]

The Shadow of Depression

Mon, 16 Mar 2009 00:20:00 -0600

What's more, the Depression changed our thinking and institutions. The human misery of economic turmoil has diminished. "American workers (in the 1930s) had painfully few of the social safety nets that today help families," Romer said. Until 1935, there was no federal unemployment insurance. At last count, there were 32 million food stamp recipients and 49 million on Medicaid. These programs didn't exist in the 1930s. Government also responds more quickly to slumps. Despite many New Deal programs, "fiscal policy" -- in effect, deficit spending -- was used only modestly in the 1930s, Romer argued. Some of Franklin Roosevelt's extra spending was offset by a tax increase enacted in Herbert Hoover's last year. The federal deficit went from 4.5 percent of GDP in 1933 to 5.9 percent in 1934, not a huge increase. Contrast that with the present. In fiscal 2009, the budget deficit is projected at 12.3 percent of GDP, up from 3.2 percent in 2008. Some of the increase reflects "automatic stabilizers" (in downturns, government spending increases and taxes decrease); the rest stems from the massive "stimulus program." On top of this, the Federal Reserve has cut its overnight interest rate to about zero and is lending directly in markets where private investors have retreated, including housing. Government's aggressive actions should reinforce some of the economy's normal mechanisms for recovery. As pent-up demand builds, so will the pressure for more spending. The repayment of loans, lowering debt burdens, sets the stage for more spending. Ditto for the runoff of surplus inventories. So, are Depression analogies far-fetched, needlessly alarmist? Probably -- but not inevitably. Even some Depression scholars, who once dismissed the possibility of a repetition, are less confident. "Unfortunately, the similarities (between then and now) are growing more striking every day," says economic historian Barry Eichengreen of the University of California at Berkeley. "I never thought I'd say that in my lifetime." Argues economist Gary Richardson of UC Irvine: "This is the first business downturn since the 1930s that looks like the 1930s." One parallel is that it's worldwide. In the 1930s, the gold standard transmitted the crisis from country to country. Governments raised interest rates to protect their gold reserves. Credit tightened, production and trade suffered, unemployment rose. Now, global investors and banks transmit the crisis. If they suffer losses in one country, they may sell stocks and bonds in other markets to raise cash. Or as they "deleverage" -- reduce their own borrowings -- they may curtail lending and investing in many countries. The consequences are the same. In the fourth quarter of 2008, global industrial production fell at a 20 percent annual rate from the third quarter, says the World Bank. International trade may "register its largest decline in 80 years." Developing countries need to borrow at least $270 billion; if they can't, their economies will slow and that will hurt the advanced countries that export to them. It's a vicious circle. Just as in the 1930s, there's a global implosion of credit. What's also reminiscent of the Depression are quarrels over who's to blame and what should be done. The Obama administration wants bigger stimulus packages from Europe and Japan. Europeans have rebuffed the proposal. The United States has also proposed greater lending by the International Monetary Fund to relieve stresses on poorer countries. Disputes could fuel protectionism and economic nationalism. What these confusing crosscurrents produce is defensiveness. No one knows how this epic struggle will end -- whether the forces pushing down the global economy will prevail over those trying to pull it up. Boom psychology gives way to bust psychology: The vague fear that something bad, call it a "depression" or whatever, is happening causes consumers and bus[...]

Obama is a Great Pretender

Mon, 09 Mar 2009 00:40:00 -0600

With today's depressed economy, big deficits are unavoidable for some years. But let's assume that Obama wins re-election. By his last year, 2016, the economy presumably will have long recovered. What does his final budget look like? Well, it runs a $637 billion deficit, equal to 3.2 percent of the economy (gross domestic product), projects Obama's Office of Management and Budget. That would match Ronald Reagan's last deficit, 3.1 percent of GDP in 1988, so fiercely criticized by Democrats. As a society, we should pay in taxes what it costs government to provide desired services. If benefits don't seem equal to burdens, then the spending isn't worth having (exceptions: deficits in wartime and economic slumps). If Obama were "responsible," he would conduct a candid conversation about the role of government. Who deserves support and why? How big can government grow before higher taxes and deficits harm economic growth? Although Obama claims to be doing this, he hasn't confronted entitlement psychology -- the belief that government benefits once conferred should never be revoked. Is it in the public interest for the well-off elderly (say, a couple with $125,000 of income) to be subsidized, through Social Security and Medicare, by poorer young and middle-aged workers? Are any farm subsidies justified when they aren't essential for food production? We wouldn't starve without them. Given an aging America, government faces huge conflicts between spending on the elderly and spending on everything else. But even before most of baby boomers retire (in 2016, only a quarter will have reached 65), Obama's government would have grown. In 2016, federal spending is projected to be 22.4 percent of GDP, up from 21 percent in 2008; federal taxes, 19.2 percent of GDP, up from 17.7 percent. It would also be "responsible" for Obama to acknowledge the big gamble in his budget. National security has long been government's first job. In his budget, defense spending drops from 20 percent of the total in 2008 to 14 percent in 2016, the smallest share since the 1930s. The decline presumes a much safer world. If the world doesn't cooperate, deficits would grow. The gap between Obama rhetoric and Obama reality transcends the budget, as do the consequences. In 2009, the stock market has declined 23.78 percent (through March 5), says Wilshire Associates. The Wall Street Journal's editorial page blames Obama's policies for all the fall. That's unfair; the economy's deterioration was a big cause. Still, Obama isn't blameless. Confidence (too little) and uncertainty (too much) define this crisis. Obama's double talk reduces the first and raises the second. He says he's focused on reviving the economy, but he's also using the crisis to advance an ambitious long-term agenda. The two sometimes collide. The $787 billion "stimulus" is weaker than necessary, because almost $200 billion for extended projects (high-speed rail, computerized medical records) take effect after 2010. When Congress debates Obama's sweeping health care and energy proposals, industries, regions and governmental philosophies will clash. Will this improve confidence? Reduce uncertainty? A prudent president would have made a "tough choice" -- concentrated on the economy; deferred his more contentious agenda. Similarly, Obama claims to seek bipartisanship but, in reality, doesn't. His bipartisanship consists of including a few Republicans in his Cabinet and inviting some Republican congressmen to the White House for the Super Bowl. It does not consist of fashioning proposals that would attract bipartisan support on their merits. Instead, he clings to dubious, partisan policies (mortgage cramdown, union check-off) that arouse fierce opposition. Obama thinks he can ignore these blatant inconsistencies. Like many smart people, he believes he can talk his way around problems. Maybe. He's helped by[...]

Wrong Turn on Housing

Mon, 02 Mar 2009 00:30:00 -0600

Housing's distress is too much supply chasing too little demand. Huge inventories of unsold homes have depressed prices and construction. Given that prices rose too high in the "bubble" -- homes were affordable only because credit was dispensed so recklessly -- much of this painful adjustment was unavoidable. But that process should be mostly complete. Here's a little-known fact: Housing may be more affordable now than at any recent time, thanks to lower prices and falling mortgage rates (now about 5 percent). The National Association of Realtors has an "affordability index" that estimates the family income needed to buy a median-priced house, assuming a 20 percent down payment and monthly mortgage payments equal to 25 percent of income. Affordability is now the highest since the index's start in 1970. Unfortunately, demand hasn't followed affordability. In January, sales of new and existing homes continued prolonged declines, dropping 10.2 percent and 5.3 percent, respectively, from December. There's a buyers' strike. Why? Shouldn't lower prices spur demand? Well, yes. There are many theories as to why they haven't. Perhaps prospective buyers can't get loans. Or people are so gloomy that they're afraid to buy. But the most important explanation is probably deflationary psychology. If yesterday's $250,000 house is now $200,000, it may be $175,000 by June. Waiting is better. Unless this deflationary psychology is broken, it becomes self-fulfilling. The more buyers wait, the more prices fall; and the more prices fall, the more buyers wait. The Obama administration essentially ignores this problem, though it can be addressed. The simplest way is to bribe prospective buyers not to wait. For example: Give them a 10 percent tax credit, up to $15,000, on the purchase price of a new home. Anyone who bought a $150,000 home would get a $15,000 tax break. The credit would expire in a year. Waiting would be costly. Buyers would delay only if they thought home prices would drop as much or more. Precisely this proposal comes from the National Association of Home Builders. Normally, it would be an atrocious idea, because it would reward people who would buy anyway and would be skewed toward wealthier buyers. But now it's worth trying. Somehow, we need to cut bloated inventories (13 months of supply for unsold new homes), curb falling prices and stimulate new construction. The hope is that once buying improves, it would feed on itself. People would join from the sidelines. The NAHB says its plan would create 250,000 jobs and cost $40 billion -- big money but tiny compared with the hundreds of billions lavished on recovery programs. The Senate included the plan in its stimulus, but it was later dropped. It wasn't an Obama priority. Some administration proposals, focused on foreclosures, are desirable. It's sensible to allow Fannie Mae and Freddie Mac to refinance older mortgages, at lower interest rates, even if homeowners' equity has dropped below today's requirement of 20 percent. This would reduce defaults and increase borrowers' spending power. Other ideas seem more dubious. For $75 billion, another proposal would subsidize homeowners so their monthly mortgage payments dropped to 31 percent of their income. Because that's still high, many of these homeowners would probably default anyway. Even worse is the "cramdown" proposal, backed by the administration. This would allow bankruptcy judges to cut mortgage payments. If passed, this would probably raise future mortgage costs, because lenders would have less access to collateral. In any case, minimizing foreclosures alone won't revive housing. If the recession and unemployment worsen, foreclosures will increase, because people without jobs and income can't meet their monthly payments. The best way to limit foreclosures is to achieve a housing and[...]

Obama's Stimulus: A Colossal Waste?

Mon, 23 Feb 2009 00:30:00 -0600

His politics compromise the program's economics. Look at the numbers. The Congressional Budget Office (CBO) estimates that about $200 billion will be spent in 2011 or later -- after it would do the most good. For starters, there's $8 billion for high-speed rail. "Everyone is saying this is (for) high-speed rail between Los Angeles and Las Vegas -- I don't know," says Ray Scheppach, executive director of the National Governors Association. Whatever's done, the design and construction will occupy many years. It's not a quick stimulus. Then there's $20.8 billion for improved health information technology -- more electronic records and the like. Probably most people regard this as desirable, but here, too, changes occur slowly. The CBO expects only 3 percent of the money ($595 million) to be spent in fiscal 2009 and 2010. The peak year of projected spending is 2014 at $14.2 billion. Big projects take time. They're included in the stimulus because Obama and Democratic congressional leaders are using the legislation to advance many political priorities instead of just spurring the economy. At his news conference, Obama argued (inaccurately) that the two goals don't conflict. Consider, he said, the retrofitting of federal buildings to make them more energy efficient. "We're creating jobs immediately," he said. Yes -- but not many. The stimulus package includes $5.5 billion for overhauling federal buildings. The CBO estimates that only 23 percent of that would be spent in 2009 and 2010. Worse, the economic impact of the stimulus is already smaller than advertised. The package includes an obscure tax provision: a "patch" for the alternative minimum tax (AMT). This protects many middle-class Americans against higher taxes and, on paper, adds $85 billion of "stimulus" in 2009 and 2010. One problem: "It's not stimulus," says Len Burman of the nonpartisan Tax Policy Center. "(Congress was) going to do it anyway. They do it every year." Strip out the AMT patch, and the stimulus drops to about $700 billion, with almost 30 percent spent after 2010. The purpose of the stimulus is to minimize declines in one part of the economy from dragging other sectors down. The next big vulnerable sector seems to be state and local governments. Weakening tax payments create massive budget shortfalls. From now until the end of fiscal 2011, these may total $350 billion, says the Center on Budget and Policy Priorities (CBPP), a liberal advocacy group. Required to balance their budgets, states face huge pressures to cut spending and jobs or to raise taxes. All would worsen the recession and deepen pessimism. Yet, the stimulus package offers only modest relief. Using funds from the stimulus, states might offset 40 percent of their looming deficits, says the CBPP's Nicholas Johnson. The effect on localities would probably be less. Congress might have done more by providing large, temporary block grants to states and localities and letting them decide how to spend the money. Instead, the stimulus provides most funds through specific programs. There's $90 billion more for Medicaid, $12 billion for special education, $2.8 billion for various policing programs. More power is being centralized in Washington. No one knows the economic effects of all this; estimates vary. But Obama's political strategy stunts the impact from what it might have been. By using the stimulus for unrelated policy goals, spending will be delayed and diluted. There's another downside: "Temporary" spending increases for specific programs, as opposed to block grants, will be harder to undo, worsening the long-term budget outlook. Politics cannot be removed from the political process. But here, partisan politics ran roughshod over pragmatic economic policy. Token concessions (including the AMT provision) to some Republicans weakened the package.[...]

A Lost Decade Ahead?

Mon, 16 Feb 2009 00:45:00 -0600

What happened to Japan in the 1990s? It did not, as some commentators say, suffer a "depression." Not even a "great recession," as others put it. Japan experienced a listless, boring prosperity. Its economy expanded in all but two years (1998, 1999), although the average annual growth rate was a meager 1.5 percent. Unemployment rose to 5 percent in 2001 from 2.1 percent in 1990. Not good, but hardly a calamity. Japan remained a hugely wealthy society. Its situation compelled attention mainly because it confounded conventional wisdom. From 1956 to 1973, Japan had grown 9 percent a year; in the 1980s, it was still growing at 4 percent. Japan was widely expected to overtake the United States as the richest, most advanced economy. It didn't. Worse, its semi-stagnation defied the notion that modern economics enabled government to ensure adequate growth. Papers were written, conferences organized, and the verdict rendered: The Japanese had botched it. After the "bubble economy" of the late 1980s burst, the Bank of Japan had eased credit too slowly. Burdened with bad loans, banks stopped lending; government didn't cleanse the banks quickly enough. Government stimulus packages were too little, too late. Naturally, the economy languished. All plausible -- and wrong. The standard analysis reassures, because it suggests that with better decisions, Japan might have avoided its prolonged slowdown. The reality seems to be that Japan's economic reverses reflect deeply held social and political values. The same might be true of us. Japan has what Richard Katz, editor of the Oriental Economist, terms a "dual economy." On the one hand, export industries (autos, steel, electronics) are highly efficient. They face intense global competition. On the other, many domestic industries (food processing, construction, retailing) are inefficient and sheltered from local competition by regulations or custom. This has suited most Japanese. Exports earned the foreign currency needed to buy food and fuel imports. Meanwhile, protected domestic industries provided the job security and social stability that most Japanese preferred to hyper-competition. While exports thrived, they -- and the supporting business investment -- were Japan's engine of economic growth. The trouble is that this system broke down in the mid-1980s. The rising yen made Japanese exports costlier on world markets. New competitors -- South Korea, Taiwan -- emerged. Japan lost its engine of growth and hasn't found a new one. That's Japan's central economic problem. Government has tried. In the 1980s, the Bank of Japan sought to offset the effect of the higher yen with cheap credit. This backfired, resulting in the bubble economy. From 1985 to 1990, Tokyo land prices rose 134 percent; the stock market boomed. Since the bubble's collapse, there have been 13 stimulus plans, reckons economist Randall Jones of the Organization for Economic Cooperation and Development. Even now, the economy is trade dependent; in December, exports dropped 35 percent from a year earlier, pushing Japan into a deep recession. What happened in Japan does not doom Obama's stimulus as futile. Sometimes, government should intervene to break the fall of a declining economy. Japan's packages probably temporarily bolstered a faltering economy. In this sense, the president is correct. Unfortunately, his stimulus is weaker than advertised, because much of the effect occurs after 2009. Still, the operative word is "temporarily." Hannity is correct in that serial stimulus plans become self-defeating. The required debt is unsustainable. At some point, the economy must generate strong growth on its own. Japan's hasn't. Will ours? Since the early 1980s, American economic growth has depended on a steady rise in consumer spending support[...]

The Bailout Isn't a Morality Play

Mon, 09 Feb 2009 00:40:00 -0600

Here's how the vicious circle works. With the economy weakening, more loans go into default. Distressed households and businesses can't meet payments. Diane Vazza of Standard & Poor's predicts that the default rate on low-grade corporate bonds will reach a record 13.9 percent in 2009 -- up from only 1 percent just two years ago. Firms that took on heavy debts in "private equity" buyouts seem highly vulnerable. Growing losses then make investors even more leery of risk. They further curb commitments. The consequences are global. Money flows into developing countries have collapsed. In 2009, they may be down 82 percent from 2007 levels, forecasts the Institute of International Finance. Private companies in these countries (Brazil, India and others) have $100 billion of maturing debts in the first half of 2009. The IIF worries that much of this debt won't be refinanced. Scarce credit spreads the global slump. So, we've gone from too much credit to too little. Contrary to popular wisdom, banks -- institutions that take deposits -- aren't the main problem. In December, total U.S. bank credit stood at $9.95 trillion, up 8 percent from a year earlier, reports the Federal Reserve. Business, consumer and real estate loans all increased. True, lending was down 4.7 percent from the monthly peak in October. But considering there's a recession, when people borrow less and banks toughen lending standards, the drop isn't disastrous. The real collapse has occurred in securities markets. Since the 1980s, many debts (mortgages, credit card debts) have been "securitized" into bonds and sold to investors -- pension funds, mutual funds, banks and others. Here, credit flows have vaporized, reports Thomson Financial. In 2007, securitized auto loans totaled $73 billion; in 2008, they were $36 billion. In 2007, securitized commercial mortgages for office buildings and other projects were $246 billion; in 2008, $16 billion. These declines were typical. Given the previous lax mortgage lending, some retrenchment was inevitable. But what started as a reasonable reaction to the housing bubble has become a broad rejection of securitized lending. Terrified creditors prefer to buy "safe" U.S. Treasury securities. The low interest rates on Treasuries (0.5 percent on one-year bills) measure this risk aversion. Somehow, the void left by shrinking securitization must be filled. There are three possibilities: (a) securitization revives spontaneously -- investors again buy bonds backed by mortgages and other loans; (b) commercial banks or other financial institutions replace securitization; or (c) the government substitutes its lending for private lending. Until now, it's been mostly (c). The Treasury and Federal Reserve, through various lending programs, are funneling funds to mortgages, student loans, small-business loans and even foreign governments. But a permanent expansion of government's lending role raises practical and philosophical issues. It might politicize lending decisions, involve huge increases in federal debt and pose long-term inflation dangers. As proposed by President Bush, the $700 billion Troubled Asset Relief Program (TARP) aimed to rehabilitate the private credit system. The Treasury would buy some of banks' bad loans. Thus strengthened, banks could increase lending and offset dwindling securitization. But the Bush gambit failed. The Treasury changed course. It injected capital directly into banks after deciding that it was too difficult to put a price on the banks' bad loans. Unfortunately, banks remain reluctant to lend because they still have lots of bad loans on their books. Now the Obama administration is crafting proposals to encourage lending. It's a genuinely hard problem. There will be ferocious debate. Will the plan work? [...]

Too Little Bang for The Bucks

Mon, 02 Feb 2009 00:40:00 -0600

"The smart grid, while a great idea, is basically a software project," says economist Marc Levinson of J.P. Morgan. "The reason utilities aren't pushing it faster is not lack of money or will, but because there are lots of technical issues and also important compatibility problems so that the various companies' grids can communicate freely with one another." As it turns out, President Obama didn't make the tough choices on the stimulus package. He could have either used the program mainly (a) to bolster the economy or (b) to advance a larger political agenda, from energy efficiency to school renovation. But Obama wanted both, and, superficially, the two can be portrayed as an enlightened partnership. "This is not just a short-term program to boost employment," Obama said recently. "It's one that will invest in our most important priorities like energy and education, health care and a new infrastructure that are necessary to keep us strong and competitive in the 21st century." In its releases, the White House gushes superlatives. The stimulus program, says one fact sheet, "launches the most ambitious school modernization program on record," "computerizes every American's health record in five years" and "undertakes the largest weatherization" -- insulation -- "program in history." What a bonanza of good stuff! Unfortunately, investing in tomorrow won't automatically stimulate the economy today. The $819 billion program passed by the House will only slowly provide stimulus. The Congressional Budget Office estimates that in fiscal 2009 (through this September) about 21 percent of the new spending and tax cuts will flow to the economy. For 2010, the estimate is another 44 percent. The total of 65 percent means that, by CBO's estimate, about a third of the $819 billion package would be spent after fiscal 2010. One reason is that some of Obama's "investments" won't occur quickly. The "smart grid" would be one. Or take the $39 billion in the House bill for added highway and transit construction. That's nearly double existing funding levels. When queried, state officials worried about how fast they could "adjust their contracting procedures" for such a big increase, reports CBO. As stimulus, the better course would simply be to give more money to states and localities -- and order them to spend it. Most would plug deficits, avoiding program cuts and layoffs. What's also sacrificed are measures that, though lacking in long-term benefits, might help the economy now. A $7,500 tax credit for any homebuyer in the next year (and not just first-time buyers, as is now in the bill) might reduce bloated housing inventories. Similarly, a temporary $1,500 credit for car or truck purchases might revive sales, which are down a third from 2007 levels. Normally, these targeted incentives would be unjustified; today, they may be necessary expedients. The decision by Obama and Democratic congressional leaders to load the stimulus with so many partisan projects is politically shrewd and economically suspect. The president's claims of bipartisanship were mostly a sham, as he skillfully maneuvered Republicans into a no-win position: either support a Democratic program; or oppose it -- and seem passive and uncaring. But the result is that the stimulus, as an act of economic policy, is hobbled. A package so large can be defended only because the economy is so weak -- and seems to be getting weaker by the moment. The central purpose is simple: halt downward momentum. Perhaps some of the out-year spending might ultimately prove useful. But the immediate need is for the stimulus package to stimulate -- now. It needs to be front-loaded; it isn't. Obama's political strategy fails to address adequately the economy's present needs[...]

Three Economic Crises In One

Mon, 26 Jan 2009 00:30:00 -0600

Second: the financial crisis. Lower lending deprives the economy of the credit to finance businesses, homes and costly consumer purchases (cars, appliances). The deepest cuts involve "securitization" -- the sale of bonds. Investors have gone on strike. In 2008, the issuance of bonds backing credit card loans fell 41 percent and those backing car loans 51 percent. Third: a trade crisis. Global spending and saving patterns are badly askew. High-saving Asian countries have relied on export-led growth that, in turn, has required American consumers to spend ever-larger shares of their income. Huge trade imbalances have resulted: U.S. deficits, Asian surpluses. As Americans cut spending, this pattern is no longer sustainable. Asia is tumbling into recession. Overcoming any of these crises alone would be daunting. Together, they're the economic equivalent of a combined Ironman triathlon and Tour de France. Consider consumer spending. The proposed remedy is the "economic stimulus" plan. This seems sensible. If government doesn't offset declines in consumer and other private spending, the economy might spiral down for several years. Last week, House committees considered an $825 billion package, split between $550 billion in additional spending and $275 billion in tax cuts. But in practice, the stimulus could disappoint. Parts of the House package look like a giant political slush fund, with money sprinkled to dozens of programs. There's $50 million for the National Endowment for the Arts, $200 million for the Teacher Incentive Fund and $15.6 billion for increased Pell Grants to college students. Some of these proposals, whatever their other merits, won't produce many new jobs. Another problem: construction spending -- for schools, clinics, roads -- may start so slowly that there's little immediate economic boost. The Congressional Budget Office examined $356 billion in spending proposals and concluded that only 7 percent would be spent in 2009 and 31 percent in 2010. Assume, however, that the stimulus is a smashing success. It cushions the recession. Unemployment (now: 7.2 percent) stops rising at, say, 8 percent instead of 10 percent. Still, a temporary stimulus can't fuel a permanent recovery. That requires a strong financial system to supply an expanding economy's credit needs. How we get that isn't clear. The pillars of a successful financial system have crumbled: the ability to assess risk; adequate capital to absorb losses; and trust among banks, investors and traders. Underlying these ills has been the consistent underestimation of losses. Economists at Goldman Sachs now believe that worldwide losses on mortgages, bonds, loans to consumers and businesses total $2.1 trillion. In March, the Goldman estimate was about half that. All the new credit programs -- the Treasury's Troubled Asset Relief Program (TARP) and various Federal Reserve lending facilities -- aim to counteract these problems by providing government money and government guarantees. Probably Obama will expand these efforts, despite some obvious problems: If government oversight becomes too intrusive or punitive, it might deter much-needed infusions of private capital into banks. Again, let's assume Obama's policies succeed. Credit flows rise. Even then, we have no assurance of a vigorous recovery, because the economic crisis is ultimately global in scope. The old trading patterns simply won't work anymore. If China and other Asian nations try to export their way out of trouble, they're likely to be disappointed. Any import surge into the United States would weaken an incipient American recovery and probably trigger a protectionist reaction. Down that path lies tit-for-tat economic nationalism that mig[...]

The Great Foreboding

Mon, 19 Jan 2009 00:40:00 -0600

Precisely this specter explains why the word "depression" is now so routinely deployed, even though we're a long way from the bread lines of the 1930s. But the Great Depression also signifies a period when we lost control. For all the New Deal programs, the Depression lasted a decade and ended only with World War II. Even in 1940, unemployment averaged almost 15 percent. It's the worry that government won't triumph over today's economy that justifies, for many people, the bleak analogies. The pessimism stretches across class and political lines. A December survey by the Pew Research Center asked whether economic conditions would be worse in a year. Among those with incomes under $30,000, 51 percent thought so; for those with incomes exceeding $100,000, the response was almost identical, 53 percent. Another question was whether unemployment would rise in the next year; 57 percent of Democrats, 64 percent of independents and 66 percent of Republicans said yes. This democratic (with a small "d") despondency has many causes. As more Americans invested in stocks, more became exposed to the market's wild psychological and financial swings. The plunge in home values has made many workers with secure jobs poorer. And, of course, layoffs themselves have become more democratic. Once, the young and blue-collar workers bore the brunt of firings. Now, managers, investment bankers, journalists, scientists -- almost anyone -- can be canned. Age confers little security. In December, almost a third of the jobless were 45 and over. What offends middle-class Americans, most of us, is economic capriciousness. People crave order, predictability and security. They want to believe that personal virtues of studying, working hard and planning will be rewarded in the marketplace. Even in good times, these ambitions are often frustrated. But in today's economy, the disconnect has widened. Setbacks and losses seem increasingly divorced from personal effort. Our whole values system seems besieged. Since World War II, Americans have only once before experienced a similar economic trauma: the double-digit inflation of the 1970s (13 percent in 1979). Work and thrift were undermined, because inflation threatened the worth of wages, salaries and savings accounts. Then as now, people were terrified, because inflation seemed uncontrollable. Starting with Lyndon Johnson, four presidents had failed. No one knew how high it might go. Then as now, we seemed unable to chart our destiny. What suppressed inflation was the brutal 1981-82 recession undertaken by Federal Reserve Chairman Paul Volcker and supported by the newly elected Ronald Reagan. Unemployment reached a peak of 10.8 percent, but gluts of jobless workers and idle factories broke the wage-price spiral and ushered in two decades of strong economic growth. Reagan won a landslide victory in 1984; his campaign featured a signature TV spot boasting that "It's morning again in America." Up to a point, there are parallels for Obama. Today's misery is a political opportunity. Reagan's popularity soared on the belief that he had re-established economic order. The country had reasserted control of its future. These gains offset the recession's severity and its hangover. In 1984, unemployment still averaged 7.5 percent. If Obama can overcome the sense of helplessness, he will surely reap much political credit. There need not be a boom -- the economy must achieve just enough sustained growth to convince most people that it's manageable and that we have not descended into a new dark age. Here, the parallels break down. Volcker and Reagan embarked on a deliberate effort to quell inflationary psychology; the question was whether the re[...]

Boomers vs. the Rest

Sun, 18 Jan 2009 00:00:00 -0600

The plight of the U.S. auto industry provides an ominous warning. For years, the "Big Three" and the United Auto Workers constructed an ever-more generous system of early retirement and retiree health benefits for autoworkers. But ultimately the costs became oppressive. The main victims: younger workers, whose jobs, wages and fringe benefits were squeezed to preserve retiree pension and health benefits. Similarly, the promises made to retiring baby boomers may impose crushing costs on society. Taxes may rise, other government programs -- from national parks to college grants -- may suffer, and long-term economic growth may slow. Again, the main victims would be today's young, who would pay higher taxes and receive fewer public services. Already, the three major programs serving the elderly population -- Social Security, Medicare and Medicaid -- account for two-fifths of federal spending. In fiscal 2008, that was $1.3 trillion out of total spending of $2.98 trillion. By contrast, all defense spending totaled $613 billion. The impending bulge of baby-boom retirees presents no good choices. Taxes? To pay for higher Social Security, Medicare and Medicaid spending would require massive increases in federal taxes -- about 50 percent from present levels by 2030, according to projections by the Congressional Budget Office. This estimate assumes that other federal programs remain constant as a share of national income. Well, what about cutting some programs? Paying for baby boomers' added retirement costs this way would require eliminating most defense spending or most other domestic programs. State and local governments face parallel, though lesser, pressures. As their workers retire, swelling spending on pensions and health benefits will intensify pressures to raise taxes or trim local services -- schools, police, mass transit. In theory, there's a way to cushion the shock: Make annual contributions sufficient to pay future benefits. Unfortunately, that's only partially occurred. States and localities still face significant unfunded costs for retirees. How large is unclear. Studies suggest that state and local government pensions were about 85 percent funded in 2006, with wide variations. Wisconsin was 100 percent funded, Illinois only 60 percent, reports the Pew Center on the States. But the stock market decline has been devastating. Through October, it reduced state and local government pensions by $1 trillion, or about a third, estimates the Center for Retirement Research at Boston College. Another problem: Promised health care benefits are largely unfunded. In 2006, these long-term costs totaled $370 billion, Pew says. What looms is a massive income transfer from workers to retirees. Ideally, we would consciously decide how much it should be. In practice, the choice occurs semi-automatically. Social Security, Medicare and pension benefits are set by law. Unless the laws are changed, the payments go out, and the pressures on taxes and other government programs are inescapable. Beyond reassuring speeches, Obama hasn't confronted the conflicts. He's been all things to all people. Rhetorically, he's for the children. But he's also for the elderly. Indeed, in the campaign, he opposed proposals for reducing the future costs of Social Security and Medicare -- higher eligibility ages, lower benefits for wealthier retirees and larger Medicare payments from retirees. Obama is in a box of his own making; he cannot fulfill his promises to children without repudiating some promises to the elderly. As a society, America is in the same box. We are loath to acknowledge genuine conflicts between generations. Everyone sympathizes with nee[...]

Obama's Health Care Headache

Mon, 12 Jan 2009 00:00:00 -0600

For the extra money, we receive no indisputably large benefit in national well-being. On some health measures (breast cancer survival rates), we do better than many countries; on some others (life expectancy), we do worse. We are constantly searching for villains to explain this unsatisfactory situation. The McKinsey study debunks some popular candidates. One is that our mixed private-public insurance system drives up costs through a high administrative overhead. Claim forms create a paperwork morass; marketing expenses add to the burden. True, U.S. overhead costs are more than double the level of other countries. But the effect is modest, because all administrative costs (including government programs such as Medicare) account for only 7 percent of total health costs. The same is true of another common scapegoat: the alleged overuse of emergency room care. In 2006, all emergency room care cost $75 billion, about 3.5 percent of total health spending. That's too small to explain overall trends. What really drives health spending, the study finds, is that Americans receive more costly medical services than do other peoples and pay more for them. On a population-adjusted basis, the number of CT scans in 2005 was 72 percent higher in the United States than in Germany; U.S. reimbursement rates were four times higher. Knee replacements were on average 90 percent more frequent than in other wealthy countries. In 2005, there were 750,000 knee and hip replacements, up 70 percent in five years, reports the journal Health Affairs. We have a health care system that reflects our national values. It's highly individualistic, entrepreneurial and suspicious of centralized supervision. In practice, Medicare and private insurers impose few effective controls on doctors' and patients' choices. That's what most Americans want. Patients understandably desire the most advanced surgeries, diagnostic tests and drugs. Doctors want the freedom to prescribe. Open-ended insurance reimbursement encourages expensive medicine by making it easier to recover the costs of clinical advances. Economist Amy Finkelstein of MIT has estimated that roughly half the real increase in per capita health spending from 1950 to 1990 reflected the spread of comprehensive health insurance. In 2006, consumers' out-of-pocket spending represented 13 percent of total health spending, down from about half in 1960. Unfortunately, this semi-automatic system may now frustrate other national goals by displacing other spending and spawning ineffective or unneeded care. On paper, there are various ways to control health spending: stricter regulations on prices and the availability of care; "market mechanisms" to push consumers toward more efficient or skimpier care. All have foundered, because they cannot be used aggressively. The reason is politics. There is no major constituency for controlling spending. Because most patients don't pay medical bills directly, they have little interest in using less care or shopping for lower-priced services. Providers (doctors, hospitals, drug companies) have no interest in limiting care. What others call "health costs" are their incomes -- wages, salaries, profits. Unless we rectify this political imbalance, efforts to control health spending may fail. We need mass constituencies that favor cost control. But our consistent policy has been to conceal the burden of health spending by burying it in untaxed corporate fringe benefits or government budgets. We could change this. We could charge the elderly more for Medicare. We could tax employer-provided health insurance as ordinary income. We could create a dedicat[...]