Monday, November 24, 2008

Plus John Kenneth Galbraith, Robert Reich, Paul Krugman, Barack Obama and Monday’s backcast looking back at the oil price bubble.

Monday’s Backcast.

But before we get to that, this podcast is being recorded before any announcement regarding Citi Bank and a bailout.  Regardless of the scenario going forward, the demise of this emblem of the American banking system displays without doubt the failure of the Bernanke-Paulson approach.  Bernanke’s clear intention was to save the banking institutions and avoid deflation.  He did this by flooding them with liquidity and turning over the Fed’s balance sheet to their bad paper.  In the end we see that the basic financing function of a financial sector is absent from the scene, but the banks themselves were not saved, and the dreaded deflation was not avoided.

Returning the financial sector to its Glass-Steagall form is the way to structure the market, empower the regional banks — who are sturdy and willing to lend — and relieve the taxpayer of the burden of insuring the colossal losses of the Wall Street players.  Until these massive zombie corporations are cleared from the field, there will be no recovery in that sector.

This continuing catastrophe has begun to deal crippling blows to the economy.  We have several takes on the situation, from Paul Krugman, Robert Reich, and John Kenneth Galbraith.  The latter from fifteen years ago.

First, with oil prices stabilizing below $50 per barrel, today’s backcast comes from February 2008.  At a time when we really had to reach to find anybody else who saw the commodities bubble…. I guess that goes for today, too…. In any event, we put up this inside a podcast on February 24, 2008.

COMMODITIES BACKCAST

Now back to the continuing and accelerating financial crash and economic meltdown.

First, from the great John Kenneth Galbraith, writing in 1993.

The possible positive lines of action against recession are three: taxes can be reduced to enhance the flow of consumer and investment spending, or so it is hoped; interest rates can be lowered to enhance investment spending and consumer purchases of houses, automobiles, refrigerators and electronics, or so it is also hoped; the Government can undertake direct, forthright job creation. This is the holy trinity. Prayer and repetitive prediction of recovery apart, there are no other lines of action.

Tax reduction has its proponents, notably among those who pay the taxes. Unfortunately, its relation to recovery is theoretical. There is the difficult question as to whether the revenues released will be spent or invested; they may be held as cash or unused bank balances. And tax reduction would increase the deficit, concern with which has now reached near paranoiac proportions. Again, better the recession.

Next, there is monetary policy: the reduction of interest rates by the Federal Reserve. This is believed to have a peculiar magic. It calls for no big bureaucratic effort, carries no threat of taxes — and a special intelligence is taken to characterize those who are associated occupationally with money.

But monetary policy works against recession by reducing interest rates and therewith rentier income. This is by no means welcomed by those who enjoy such income. …

Additionally, there is the sad fact that in a recession monetary policy doesn’t work. The elasticity of the response to reduced interest rates is then very low. People and firms spend and invest, or fail to do so, pretty much as before.

Finally, there is direct Government expenditure and employment. For those resting comfortably in recession, this is the worst of all. It could raise prices, risk inflation. Much worse, it promises higher taxes at some time yet to come. …

John Kenneth Galbraith, 1993

Now, Robert Reich, Obama economic adviser and Labor Secretary under Bill Clinton, writing on October 26 in the American Prospect, on income disparity and depressions.

The specific financial machinations that lead to collapse are always different, but inequality at the levels America reached in 2006 (the last year for which we have data) is a reliable sign of danger. The richest 1 percent of Americans last year took home 23 percent of total national income. Back in 1980, the richest 1 percent took home 8 percent of total income. The last time the top 1 percent took home more than 20 percent of total income was in 1928, just before the Great Crash.

I’m not predicting another Depression, but the parallels between what’s happening now and what happened 80 years ago are striking. In the 1920s, wealth and income began concentrating at the top for a number of reasons: a huge consolidation of industry that richly rewarded certain investors and executives; the emergence of Wall Street as a driving force in the economy as the nation shifted toward debt financing, generating large gains for financiers; and increasing globalization, putting large sums of money into the hands of those commanding the heights of international commerce.

What was the response of Washington to this increasing concentration of income? President Calvin Coolidge slashed taxes on the highest income earners. At the same time he pursued anti-union policies that reduced the bargaining leverage of blue-collar workers, resulting in lower wages for them. The only way most Americans could maintain their slice of the pie was to go deeper into debt. Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled.

Robert Reich.  Reich is not included in the company of the official Obama economic team, many of whom will be announced tomorrow at the president-elect’s news conference, but he has been front and center in the media.  One supposes he must have some sort of mission for the transition team, and we hear him coming down hard on the current administration, particularly on their inability or unwillingness to help Main Street.

Now, here is the issue du jour, the vacuum of power in the last days of the Bush administration.  Point man on this issue was Paul Krugman.  Actually, Demand Side suggested months ago that the new administration had to be open to governing prior to inauguration.  It may not be politically wise, logistically possible, or legally do-able, but it is economically essential.

Here, Paul Krugman, excerpted from Friday’s New York Times, under the head,

The lame-duck economy

NYT November 21

….in 1932, a long era of Republican political dominance came to an end in the face of an economic and financial crisis that, in voters’ minds, both discredited the Republican Party’s free-market ideology and undermined its claims of competence. And for those on the progressive side of the political spectrum here in the U.S., these are hopeful times.

There is, however, another and more disturbing parallel between 2008 and 1932 - namely, the emergence of a power vacuum at the height of the crisis. The interregnum of 1932-1933, the long stretch between the election and the actual transfer of power, was disastrous for the U.S. economy, at least in part because the outgoing administration had no credibility, the incoming administration had no authority and the ideological chasm between the two sides was too great to allow concerted action. And the same thing is happening now.

It’s true that the interregnum will be shorter this time: FDR wasn’t inaugurated until March; Barack Obama will move into the White House on Jan. 20. But crises move faster these days.

How much can go wrong in the two months before Obama takes the oath of office? The answer, unfortunately, is: A lot. Consider how much darker the economic picture has grown since the failure of Lehman Brothers, which took place just over two months ago. And the pace of deterioration seems to be accelerating.

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The Obama Team will likely be officially announced by the time you get this podcast.  At present the likely composition is Tim Geithner at Treasury, Bill Richardson at Commerce, Larry Summers as head of the Economic Council, Austan Goolsbee as Chair of the Council of Economic Advisers, Jason Furman at NEC, Peter Orzag as Budget Director. Summers is suspect.  It was his T’s  “Targeted, Timely, Temporary” mantra last January that convinced lawmakers to do “checks in the mail” stimulus.  It should have had the fourth T — “Timid.”

But at least there is a return to competence with the Obama team, and an apparent willingness to (like Roosevelt) listen and experiment until something works.

The question is, Where is Paul Volcker?  One hopes he has the portfolio of reconstructing the financial sector.  As we noted the accelerating meltdown  — now including Citi — demonstrates, the Bernanke strategy of liquifying the banks with a fire hose has failed, not only to salvage a the financing function of the economy, but to save the banks themselves, and to prevent the dreaded deflation.

The talk on Sunday was all good, particularly on increasing the scale of the proposed stimulus package.  We again call for citizen sacrifice in the form of adopting the blue ribbon panel on infrastructure’s proposal for an 83 cent per gallon gasoline tax, phased in, to produce $250 billion in needed surface transportation infrastructure each year for the next 50 years.

We could say more, but we want to squeeze in the Saturday broadcast of our favorite president elect.

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