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Realities vs Rhetorics: Economy, Policy, Real Data (Updates)

Long past time for another post and, as things cycle around, it probably should be on the state of the economy. But we've hammered that a whole bunch and nothing has changed our conclusions (The Vast, Ignored Difference: Economic Bottoming vs Recovery, Drugged Wallabies, Crop Circles and World Economies (Refreshes). We did keep repeating that the slowing of decline was not either green shoots or a harbinger of recovery (our constant theme for months now !) so the good news is that we're hearing that reflected all over now. Alleluia ! So we're going to spend less time on pure economics and focus more on the conundrums and policy dilemmas we find ourselves in. The level of mis-understanding about the state of the economy, the outlook and the role of government policy is just astounding; and it rests on a fundamental mis-understanding of how cycles and stimulus work. That will be our focus. But just to hattip last week's economic data take a look at the chart set, which shows monthly data back to Jan00 and Jan93 and quarterly back to Q160 on a YoY% basis. Despite the "it's better, it's better" meme running around in fact it's flattened off around approx. -10% ! The real thing to note is this: every single data series in the last few weeks has looked exactly like this (including revenues being reported in the earnings announcements !). Like we said the only ray of light is that the fact that things are NOT good and this is going to be a very weak and drawn out recovery has dawned among a wide group of observers.

Current Cycle and Strategic Outlook

When consumer demand drops as badly as this businesses will also cut their spending. In fact increases in hiring and investing happen ONLY after a recovery begins as companies don't need to add to capacity until demand uses up existing capacity. That's why employment and capex are lagging indicators. In normal times the economy naturally follows a cycle where rising consumer demand leads to more business spending which generates new hiring which in turn leads to more spending. The Fed can help mitigate the worst extremes of this as long as we're in a normal environment thru interest rate management. But we're in a once in multiple generation state where things are anything but normal. THE ONLY SOURCE OF DEMAND IS GOVERNMENT SPENDING. Without it we'd be in much worse circumstances, with some serious risk of Depression 2.0. If the Fed and Treasury had screwed up last Fall we'd have had one anyway. This 4-panel composite tries to convey all that and link it to our strategic alternatives. We've likely avoided GD 2.0 but are now trying for a weak recovery instead of a long L-shaped malaise. There are a bunch of "abort" points we need to navigate until we get back to the self-priming normal cycle of organic growth. But even if that works everybody from the Fed to Roubini is seeing poor long-term growth prospects (2% or so), far below potential, for years. To restore long-term growth we've got to invest in things like infrastructure, energy, healthcare and education to re-base the economy.

Stimulus Package Structure

A couple of weeks ago I sat thru an online presentation by GE Healthcare discussing it's electronic medical records and physicians practice software solutions. As the result of a sliver of a sliver of a sliver in the stimulus package they are offerring low-cost financing to the 95% of doctors who haven't yet even begun to think about the problem. That sliver was pretty well-crafted. When you look at the breakdown of the stimulus package it was pretty well constructed. There was a big chunk that was in tax cuts and transfer payments, e.g. extending unemployment benefits. That was and is a big help in mitigating some of the downturn and employment impacts. But 2/3 of the package will hit later on this year and thru next. The other thing that the package does is start laying the groundwork for not only getting us past the abort point but also in jump-starting a structural evolution to a re-based economy.

Now there's no denying that the process of rushing thru the package saw some pork loaded in but the extent has been enormously exaggerated. Some reasonable and responsible estimates put it somewhere between infinitesimal and ~3%, a minor political price to pay for getting something that large out that fast and that reasonably well-crafted. When people criticize the package they have no clue as the real challenges. First off the package was about as large as could have been passed given the political situation. Second, when you examine the graphic and think about my anecdote, it's well-crafted. It's not like folks haven't been examining much of this for decades, e.g. infrastructure spending requirements. ANOTHER key thing to keep in mind is that the package is the down payment and tabs into follow-on legislation on the budget, education,  energy and healthcare. Taken all together and in conjunction with what the Fed and Treasury are doing to restore the credit markets and re-regulate the Finance Industry this is comprehensive and integrated a system of initiatives as we've seen in almost four decades. Finally, and this speaks to the call for a 2nd stimulus, what's authorized is about as much or more as the current mechanisms of the various Federal departments can handle. Or beyond. To make this work we're going to need a revolution in government operations that's one of the major hidden challenges. And if we end up needing a second stimulus we'll need it on the state and local levels, as the CA. nightmare tells us. The bottomline here is that people are doing the best they know how, it all hangs together and it's all at the limits of what we can manage. In many senses !

The Deficit Bogeyman

A really key thing, setting aside the partisan political posturing that's done to try and exploit old shibboleths that are unworkable and discredited, is that most folks are judging things thru ideological blinders. If we've learned anything in the last couple of years is that the simple common wisdom is no substitute for actually knowing what you're doing. Faced with a problem of this scope and magnitude and complexity what you want is a set of approaches that are as complex as necessary and understand the feedback loops built into a system. Simple answers just won't do it. One of the key bogeymen is the fear of excess deficits so let's take a look at that and try to make it a little clearer. If you're with us this far we hope it's crystal clear that we have NO choice but to spend or face a decade+ long period of 1% growth or less; and hope it doesn't turn over into a depression which is still a possibility. This little composite collection we've accumulated over several years might help.

Despite supply-side idolatry what Reagan actually did to restore the economy was create the most massive deficits in post-WW2 history. In other words he pursued as Democratic like a policy as anybody had in decades. The good news is that it worked and got the economy back on a growth path. The bad news is that the resulting deficits were massive. Clinton, bless his pointy little head(s), not only eliminated the deficit but briefly put us in surplus thru a combination of fiscal discipline and taking advantage of reduced military spending. Unfortunately BushII, returning to idolatrous worship, chose to both cut taxes AND enormously expand spending. Some of which was unavoidable. But the net result is that we came to the end of a mini-boom and entered the worst recession extremely far in the hole. When you look at the sources of the current and projected deficit about $200B of $1.3T is due to the current administration. The other thing to keep in mind is the odd thing that if we get back on a higher growth path tax collections will increase and we'll have less of a deficit burden and pay it down faster. In the long-run it really matters what you spend your money on - invest it for future growth or chew it up in frivolous short-term spending. So far we're more on the former path than the latter. When you combine that with the even deeper structural shift of the public from over-borrowing consumers to folks who will be forced to be savers this isn't going to be hard to finance; nor will it crowd out private investment. Initially because there's no demand for private investment and then because a growing economy where Savings > Investment throws off lots of cash. In fact if we can keep this all together for the next decade we're going to be in a far...far better place then we're in now or would have been otherwise.

BtW - there's a whole slew of readings and some more charts after the break that span current economic data, the long term outlook, oil/commodities, the mounting problems in China with Rio Tinto that will make sustaining their growth more difficult, a bunch on the policy issues and some more on re-thinking the relationship between markets, policy and institutions.You might want to pay particular attention to the collection to the second China collection if you want to understand a) the long-term problems they ARE creating, b) what a dangerous stimulus program looks like and c) whether we can count on them to pull us out of this (otherwise HA !).

Bon Appetit' !

UPDATEs:

We added a Bloomberg clip on the failure of a recent Chinese bond market auction that discusses the general Asian economic and financial outlook along with a chart on worldwide monetary aggregates from Macro Man. The conjoint point here is that China has pumped monetary stimulus unlike any other player yet, unlike the US, China's money is flowing into consumer spending and more highly questionable loans. In the US the increases in the monetary base has NOT entered the credit markets because of reduced velocity; i.e. the money is sitting on bank balance sheets and credit is tightly constrained. Not good for the US and terrible for China and the worldwide impact ! Be warned.

Current Economic Situation

When We Get “There”, Will We Know It? Back in April, our forecast update commentary was entitled, “Are We There Yet?” The “there” referred to a resumption of real growth in the overall economy. Our answer in April was “no,” which also happens to be our answer in July. When will we get there? Our answer in April was the fourth quarter of this year, which also happens to be our answer now. Assuming we get there in the fourth quarter, would most households and businesses in America know it if they were not so informed by the media? Probably not. We anticipate another “jobless recovery,” which implies a relatively feeble one. We would not be surprised to hear terms early in 2010 such as “double dip.” Why do we anticipate a feeble recovery? Firstly, we believe that although the private financial sector has stabilized, it still is a long way from functioning in a normal fashion. Net lending by the private financial sector contracted in the first quarter of this year at an annualized rate of $1.6 trillion (see Chart 1) – the first quarterly contraction on record since the 1952 inception of this series. The combination of inadequate capital to increase net lending along with deteriorating credit quality on the part of potential borrowers led to the most severe credit crunch in the post-WWII era. Although a number of financial institutions have bolstered their capital positions in the first half of this year, some of that newly-raised capital is likely to “depreciate” significantly in the second half of this year and into 2010 as losses are incurred in connection with commercial mortgages and household debt – residential mortgages along with credit card and auto-loan debt. So, anything like normal net lending by the private financial system is unlikely to commence until 2011, at the earliest. History suggests that although economic recoveries can occur with a crippled financial system, those recoveries tend to be muted – witness the 1991 recovery.

Retail Sales in June On a monthly basis, retail sales increased 0.6% from May to June (seasonally adjusted), and sales are off 9.6% from June 2008 (retail ex food services decreased 10.3%). Excluding autos and gas, retail sales fell again in June. The following graph shows the year-over-year change in nominal and real retail sales since 1993. The Census Bureau reported that nominal retail sales decreased 10.3% year-over-year (retail and food services decreased 9.6%), and real retail sales declined by 9.7% on a YoY basis. The second graph shows real retail sales (adjusted with PCE) since 1992. This is monthly retail sales, seasonally adjusted.This shows that retail sales fell off a cliff in late 2008, and may have bottomed - but at a much lower level. Maybe the cliff diving is over, but retail sales are still at the bottom of the cliff ...

More Inventory Correction The Manufacturing and Trade Inventories and Sales report from the Census Bureau today showed more evidence of declining inventories. The above graph shows the 3 month change (annualized) in manufacturers’ and trade inventories. The inventory correction was slow to start in this recession, but inventories are now declining sharply. However, even with the sharp decline in inventories, the inventory to sales ratio has only declined to 1.42 in May - since sales have fallen sharply too. There has been a race between declining sales and declining inventory. Even as sales start to stabilize (appears to be happening), inventory levels are still too high compared to the lower sales levels, and further inventory reductions are probably coming. Inventory:Sales Ratio

Industrial Production Declines, Capacity Utilization at Record Low in June This graph shows Capacity Utilization. This series is at another record low (the series starts in 1967). In addition to the weakness in industrial production, there is little reason for investment in new production facilities until capacity utilization recovers.

Housing Starts Fall 46% Yet another set of odd and misleading coverage on Housing Starts. BUILDING PERMITS: Privately-owned housing units authorized by building permits in June were at a seasonally adjusted annual rate of 563,000. This is 8.7% (±3.0%) above (revised) May rate, but is 52.0% (±3.6%) below the June 2008. HOUSING STARTS: Privately-owned housing starts in June were at a seasonally adjusted annual rate of 582,000. This is 3.6% (±11.3%)* above the revised May estimate but is 46.0% (±4.3%) below the June 2008. What can we tell from this data? Nothing about monthly change in Starts (data points less than the margin of error are not statistically significant); We can say that permits were up month to month, although how much of that is seasonal is hard to decipher. The year-over-year data is much clearer: New Starts down 46%, Permits down 52%. Not exactly green shoot materials here — but given the enormous inventory overhang, less new building is better. And since year-over-year compares the same month, seasonality is not a factor. Incidentally, much of the media reportage on this was simply innumerate — the numerical equivalent of illiteracy. Not just a little wrong, but totally, embarrassingly incorrect.

Mortimer Zuckerman: The Economy Is Even Worse Than You Think The recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. What we can see on the surface is disconcerting enough, but the inside numbers are just as bad. The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion. Here are 10 reasons we are in even more trouble than the 9.5% unemployment rate indicates: - June's total assumed 185,000 people at work who probably were not. The government could not identify them; it made an assumption about trends. But many of the mythical jobs are in industries that have absolutely no job creation, e.g., finance. When the official numbers are adjusted over the next several months, June will look worse. - The number of workers taking part-time jobs due to the slack economy, a kind of stealth underemployment, has doubled in this recession to about nine million, or 5.8% of the work force. Add those whose hours have been cut to those who cannot find a full-time job and the total unemployed rises to 16.5%, putting the number of involuntarily idle in the range of 25 million. Since consumer spending is the economy's main driver, we are going to have a weak consumer sector and many businesses simply won't have the means or the need to hire employees. After the 1990-91 recessions, consumers went out and bought houses, cars and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so. The paycheck has returned as the primary source of spending. This process is nowhere near complete and, until it is, the economy will barely grow if it does at all, and it may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of excessive debt has been completed. Until then, the economy will be deprived of adequate profits and cash flow, and businesses will not start to hire nor race to make capital expenditures when they have vast idle capacity.

Energy ==> Commodities

Oil Falls to Eight-Week Low on Concern for Economy, Fuel Demand Crude oil fell to an eight-week low in New York on concern that the economy and fuel consumption won’t recover this year. Oil futures retreated after Treasury Secretary Timothy Geithner warned that the American economy faces “enormous challenges.” Prices on July 10 capped their biggest weekly decline since January as U.S. consumer confidence fell and fuel stockpiles increased for a fourth week. “Prices are probably going to go lower this week because of worries about the economy,” said Phil Flynn, vice president of research at PFGBest, a Chicago-based brokerage. “We have several big economic reports this week and they better come out better than expected. Otherwise, there will be further pressure on oil prices.”

China: Governance vs Business

China Accuses Rio Workers of Stealing Price Data Four employees of miner Rio Tinto Ltd. detained on spying charges are accused of bribing Chinese steel company managers to obtain secret information on China's position in talks on iron ore prices, state media said Friday. The four employees were detained Sunday while Rio was negotiating on behalf of global iron ore suppliers with Chinese steel mills. The government said Thursday they are accused of stealing state secrets. They include an Australian citizen, Stern Hu, the Shanghai-based manager of Rio's Chinese iron ore business. Australian diplomats met Friday with Hu for the first time since his detention, Foreign Minister Stephen Smith said. He said details of the meeting would be released later. "In 2009 during negotiations between Chinese and foreign companies on iron imports, Hu and his people used illegal methods by bribing personnel of Chinese steel production units to steal Chinese national secrets, which caused damage to China's national economic safety and interests," newspapers said, citing a statement from the Ministry of State Security, China's main internal intelligence agency. The material included summaries of meetings of Chinese negotiators, the newspaper 21st Century Business Herald said, citing unidentified sources. It said that would allow Rio to know "the Chinese iron ore negotiating team's bottom line." Rio, the world's third-largest mining company, is acting as lead negotiator for global iron ore producers in price talks with Chinese steel mills. China is pushing for sharp price cuts following years of repeated increases. The other major suppliers are Australia's BHP Billiton Ltd. (NYSE:BHP) and Brazil's Vale SA.China's communist government regards steel production as a strategic industry and treats a wide range of economic data as secret. Information on steel company ore costs, profits and spending on technology all are considered secrets, according to news reports.The maximum penalty for an espionage conviction is life in prison.

China Ignites Rebound China's government has turned its economy around far faster than most thought possible, driving share prices up Wednesday to close at a 13-month high on some of the heaviest trading since 2007. Economists estimate that China's economy likely expanded by close to 8% from a year earlier in the second quarter, up from 6.1% in the first quarter. The official figure was scheduled to be announced early Thursday in Beijing. When measured in the same terms as other major economies -- an annualized quarter-on-quarter comparison -- China's growth in the second quarter could be on the order of 15%, some private economists estimate. Even if the surge moderates in coming quarters, many analysts say China will very nearly meet its target of 8% growth for all of 2009. The Shanghai stock market's benchmark index has gained 75% this year as the Chinese outlook has improved, with factory output, bank lending and commodity imports all continuing to accelerate in the past few months. Now, authorities face increasing questions about how long this growth can last, and how quickly the world's third-largest economy can be weaned off its massive stimulus before longer-term problems take root. The sustainability of this state-driven growth spurt is a critical issue for the global economy. The success so far of China's stimulus has been one of the few bright spots in the worst global downturn in a generation, with all advanced economies expected to contract this year.

For all the talk this year about the Chinese refusing to buy U.S. bonds, the real story is about the People’s Republic of China’s failure to find buyers for the equivalent of $1.7 billion of its debt because too many investors showed no interest at auctions that would be considered disastrous if their outcomes were repeated on Wall Street.

Failing China Bond Sales Show Asia Debt Auctions No Competition With U.S. Other Asian countries face similar difficulties. India’s underwriters had to purchase 3.1 billion rupees ($64 million) of 25-year securities they were unable to sell at a July 10 auction. Vietnam and the Philippines abandoned offerings because investors demanded higher yields than the governments were willing to pay. China’s 11.9 billion yuan in unsold short-term debt represented 14.3 percent of the 83 billion yuan it offered in three sales this month.While Asian local currency debt returned 94 percent from 2001 through 2008, the lack of demand signals that the rally is coming to an end, according to Allianz SE, Aviva Investors Ltd. and UOB Asset Management Ltd. Central banks in India, Thailand and Malaysia have stopped reducing interest rates to keep inflation from accelerating. China has started pushing money- market costs higher to slow record lending.

US Economic Policy: Stimulus vs Headlines

Obama Stimulus Fails to Reboot Economy as Multiplier Effect Shows No Life  The debate over whether the $787 billion stimulus package is sufficiently large or efficiently designed obscures a broader question, some economists say: Can any fiscal measure pull the economy out of the recession? With credit still crimped and the outlook for consumer demand gloomy due to rising unemployment and increased personal saving, no amount of government intervention will be able to stanch the hemorrhaging of jobs and quickly ease the U.S. out of its deepest recession in a half-century, they said. Even though a second stimulus package is unlikely at this point, those advocating such a measure said it may be needed precisely because the effects of the first have been so modest. The combination of rising unemployment and thrifty consumers “definitely lowers the multiplier effect” of every stimulus dollar spent, said Dean Baker, a co-director of the Center for Economic and Policy Research in Washington. “That just means you need more stimulus. There’s really no alternative.” Obama administration officials such as Treasury Secretary Timothy Geithner said the measure needs time to work and are appealing for patience. For the moment, the initial measure has shown little impact. The net worth of households has fallen almost 22 percent, by almost $14 trillion, since 2007, to the lowest level in five years. House prices have fallen more than 32 percent from their 2006 peak, according to the S&P/Case-Shiller national index, while the Standard & Poor’s index of 500 stocks is 40 percent below its October 2007 level. The crisis reminded Americans that home values can fall as well as rise and that bull markets don’t last forever, causing consumers to stash away a much larger portion of their incomes. Government data showed that the household savings rate rose to 6.9 percent in May, from zero in April 2008. The May figure is the highest in almost 16 years.

Stimulus Said to Be Moving Faster The Obama administration says it has been on a "learning curve" with the economic-stimulus package but has now figured out how to spend some of the available billions more quickly. Many tax cuts, which account for a third of the $787 billion package, have already taken effect. But only $60.4 billion of the remaining $499 billion has been spent. Most of the money was always likely to be spent this summer at the earliest as departments wrestled with the increased workload and new requirements imposed by the bill. The White House isn't changing its goal of spending 70% of the funds by September 2010. But amid worries about steep unemployment, the White House has been pressuring agencies to get some money out the door more quickly. "It was a learning curve and as we learned more we were able to accelerate more," said Ed DeSeve, a senior White House adviser. The Department of Education, for example, scrapped the idea of giving $8.8 billion of general aid to states in two phases and decided to send them all the money after their application was approved. The Department of Labor said it had distributed the bulk of its $38.5 billion in stimulus money within 30 days of the law's enactment, but that "it takes time" for states, in turn, to move the money. The White House told agencies to find ways to cut red tape, both for making large transfer payments to states and running big competitions for grants. Agencies were also instructed to work more closely with states to help them spend the money once they received it. Some agencies have indicated there isn't much more they can do. At the Commerce Department, a senior official said the time frame for a competition to give out about $4.7 billion in grants to build broadband networks had been condensed. But in an effort to make the money widely available, the department is deliberately staggering the pace at which it gives out the grants, giving more groups chances to apply. Another $1 billion of the agency's $7.9 billion will be spent next year for the 2010 Census.

America’s Sea of Red Ink Was Years in the Making There are two basic truths about the enormous deficits that the federal government will run in the coming years. The first is that President Obama’s agenda, ambitious as it may be, is responsible for only a sliver of the deficits, despite what many of his Republican critics are saying. The second is that Mr. Obama does not have a realistic plan for eliminating the deficit, despite what his advisers have suggested. The New York Times analyzed Congressional Budget Office reports going back almost a decade, with the aim of understanding how the federal government came to be far deeper in debt than it has been since the years just after World War II. This debt will constrain the country’s choices for years and could end up doing serious economic damage if foreign lenders become unwilling to finance it. Mr. Obama — responding to recent signs of skittishness among those lenders — met with 40 members of Congress at the White House on Tuesday and called for the re-enactment of pay-as-you-go rules, requiring Congress to pay for any new programs it passes. The story of today’s deficits starts in January 2001, as President Bill Clinton was leaving office. The Congressional Budget Office estimated then that the government would run an average annual surplus of more than $800 billion a year from 2009 to 2012. Today, the government is expected to run a $1.2 trillion annual deficit in those years. You can think of that roughly $2 trillion swing as coming from four broad categories: the business cycle, President George W. Bush’s policies, policies from the Bush years that are scheduled to expire but that Mr. Obama has chosen to extend, and new policies proposed by Mr. Obama.  The first category — the business cycle — accounts for 37 percent of the $2 trillion swing. About 33 percent of the swing stems from new legislation signed by Mr. Bush. That legislation, like his tax cuts and the Medicare prescription drug benefit, not only continue to cost the government but have also increased interest payments on the national debt. Mr. Obama’s main contribution to the deficit is his extension of several Bush policies, like the Iraq war and tax cuts for households making less than $250,000. Such policies — together with the Wall Street bailout, which was signed by Mr. Bush and supported by Mr. Obama — account for 20 percent of the swing. About 7 percent comes from the stimulus bill that Mr. Obama signed in February. And only 3 percent comes from Mr. Obama’s agenda on health care, education, energy and other areas. If the analysis is extended further into the future, well beyond 2012, the Obama agenda accounts for only a slightly higher share of the projected deficits.

Keynes Arouses Fed as ECB Looks for Monetary Exit: Mark Gilbert The worst crisis in modern financial history is set to culminate in an ideological clash, pitting the Federal Reserve against the European Central Bank in a debate that will shape the global economy for at least the next decade. The catchphrase that will dominate central bank meetings for the rest of the year is “exit strategies;” now that the markets are showing some semblance of normality, how quickly should they be unhooked from the life-support systems that have transfused the banking system with government funds?  Act too quickly in raising official interest rates and reversing the flow of liquidity, and economies might slump back into recession, bringing Federal Reserve Chairman Ben Bernanke’s well-documented nightmare about deflation to life. Wait too long, though, and the seeds of the next crisis may be sown as policy remains lax and encourages yet more financial bubbles that will inevitably burst. The outcome seems binary; our unelected guardians of stability will either awaken the ghost of inflation past, or condemn us to a deflationary spiral. Unfortunately, the most unlikely result seems to be a return to the Goldilocks economy of not too hot, not too cold that endured for a decade. Ideally, policy makers will act simultaneously around the world, with concurrent elimination of emergency measures. Moreover, ending the different kinds of local therapy being applied, via taxes, interest rates, distressed-debt purchases or whatever, should keep a balance, with some medications maintained while others are withdrawn. Finally, the cessation of crisis policies must not leave business short of credit; the liquidity can’t just end up in the hands of the banks, it must flow into the economy -- otherwise, what was the point? None of this will be easy. Russell Jones, the head of fixed-income strategy at RBC Capital Markets in London, summed up the quandary in a research note this month. “History suggests that after severe financial traumas and the painful recessions that follow them, macroeconomic policy support should not be removed too soon and tightening monetary and fiscal policy simultaneously can be particularly hazardous,” he wrote. The battle lines are being drawn. On the Keynesian side of the equation is the Fed (with an acknowledgment that these are strange days indeed when the U.S. seems more left-leaning than mainland Europe), under a new president who has no qualms about spending public money to either prop up or appropriate private companies, much as John Maynard Keynes might have advocated.

What the Future Holds: Re-thinkings and Structural Change

What If? The whole world, it seems, is wrapped around the axle about exit strategies from putatively unsustainable policies: (1) the Fed’s bloated balance sheet, with some $800 billion of excess reserves sloshing ‘round the banking system, in the context of an effective zero Fed funds rate; and (2) the Treasury’s huge budget deficit, unprecedented in peace time and set to stay huge, implying a Treasury debt/GDP ratio approaching 100% within a decade’s time. In any event, there does not seem to be any serious consensus as to how the policy mix should be adjusted, if at all, despite clear and present evidence of massive unemployment and underemployment, which is putting downward pressure on nominal personal income (the product of fewer jobs, fewer hours and decelerating wages, almost to the zero line). This is not the stuff of a self-sustaining revival in aggregate demand. Thus, my tentative conclusion is that maybe the consensus professional economist view is that America should simply accept that it’s going to have its version of Japan’s lost decade, the Calvinist aftermath of the preceding sin of booming growth on the back of ever-increasing leverage and mal-investment. In a follow-up (similarly wonkish) paper2 in 1999, Professor Krugman refined his argument, stressing that the core of his thesis could be implemented through a credible inflation target that was appreciably higher than the prevailing negative inflation rate in Japan. Thus, he was not so much arguing that the Bank of Japan should act irresponsibly, but rather act irresponsibly relative to orthodox, conventional thinking, which itself was irresponsible, in that it emphasized the need for an eventual exit strategy from liquidity trap-motivated money printing. To get out of the trap, he emphasized, the central bank needed to radically change expectations to the notion that there was no exit strategy, at least until inflation was appreciably higher – not just inflation expectations, but inflation itself. Only then would the commitment to higher inflation be credible, with the central bank not just talking the reflationary talk, but walking the reflationary walk, turning deflationary swamp water into reflationary wine. Naturally, the Bank of Japan didn’t listen to Krugman at the time; orthodoxy is as orthodoxy does.

In Slumping Economy, a Shift in Shopping Habits Economics correspondent Paul Solman speaks with author Paco Underhill about how consumer habits have changed during this recession

The Invisible Hand, Trumped by Darwin? IF asked to identify the intellectual founder of their discipline, most economists today would probably cite Adam Smith. But that will change. Economists’ forecasts generally aren’t worth much, but I’ll offer one that even my youngest colleagues won’t survive to refute: If we posed the same question 100 years from now, most economists would instead cite Charles Darwin.  Darwin, renowned for the theory of evolution, was a naturalist, not an economist, and his view of the competitive struggle was different from Smith’s in subtle but profound ways. Growing evidence suggests that Darwin’s view tracks economic reality much more closely. Smith is celebrated for his “invisible hand” theory, which holds that when greedy people trade for their own advantage in unfettered private markets, they will often be led, as if by an invisible hand, to produce the greatest good for all. The invisible hand remains a powerful narrative, but after the recent economic wreckage, skepticism about it has grown. My prediction is that it will eventually be supplanted by a version of Darwin’s more general narrative — one that grants the invisible hand its due, but also strips it of the sweeping powers that many now ascribe to it. The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species. In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles with other males for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods. In Darwin’s framework, then, Adam Smith’s invisible hand survives as an interesting special case. Competition, to be sure, sometimes guides individual behavior in ways that benefit society as a whole. But not always.  Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race. In the marketplace, such reward structures are the rule, not the exception. The income of investment managers, for example, depends mainly on the amount of money they manage, which in turn depends largely on their funds’ relative performance.

Posted by dblwyo on July 22, 2009 04:56 PM |

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